What Is Federal Income Tax Liability?

A young woman filing her taxes.
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Federal income tax liability is an amount you owe the Internal Revenue Service for unpaid taxes. Total liability is not just the amount shown on a tax return as a "balance due"; it also includes other charges the IRS can assess on an account. These other charges continue to accrue over time, which means the longer a balance exists, the higher the federal tax liability becomes. Federal income tax liability can be broken down into three main categories: principal tax, penalties and interest.

Principal Tax

Principal tax is the cornerstone of federal tax liability; it is the base amount on which most penalties and interest are calculated. Principal tax comes from three different types of assessments:

  • Original balances
  • Substitute balances
  • Additional assessments

Original Balance

An original balance is the amount shown as "balance due" on a return you prepare and submit. Original balances may also include adjustments made from amended returns.

Substitute Balance

A substitute balance is an amount owed as a result of the IRS preparing and posting a return on behalf of a taxpayer. This differs from an original balance in that the taxpayer did not submit an original return and the IRS prepared one instead. Substitute balances are generated either by using information provided by third parties, such as W-2 or 1099 forms, or by estimating a substitute balance by using past information submitted by the taxpayer. Substitute balances can be corrected by filing an original return.

Additional Assessments

At times, the IRS may assess additional taxes. Additional tax assessments do not include penalties and interest; those are separate charges. Additional assessments include other principal tax balances as a result of an audit or calculation corrections made due to mathematical errors.

Penalties

Penalties are charges for failing to comply with filing and payment laws. The IRS sets deadlines for filing returns and paying principal balances. When those deadlines are not met, the IRS may charge a penalty. The three most common penalties are:

  • Failure to file penalty
  • Failure to pay (late payment) penalty
  • Penalty for underpayment of estimated taxes

In most cases, penalties are based on principal amounts owed, so a return showing a zero balance or a refund may not have a penalty. However, some businesses may still owe a penalty if a return is filed late, even when zero tax is due.

Interest

Credit card issuers and loan servicers charge interest on balances due, and the IRS is no exception. Interest on unpaid taxes accrues for as long as a balance is due. This is true even if a payment plan is established to pay off the debt. Interest is calculated on the entire balance, which includes principal tax, penalties and accrued interest. The quicker the tax liability is paid, the more the taxpayer saves in the long run.

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