Compensation Income

Compensation Income

• Compensation income is remuneration for services performed in an employer-employee relationship
• It includes payment in cash or in kind
• Remuneration is compensation income even after the employer-employee relationship ends

Classification of Compensation Income

• Regular compensation includes basic salary and fixed allowances paid per payroll period
• Supplemental compensation includes payments apart from regular compensation
• Examples of supplemental compensation are overtime, commission, profit sharing, monetized leave, fringe benefits for rank-and-file employees, hazard pay, and taxable 13th-month pay

Fringe Benefits

• A fringe benefit is any good, service, or other benefit granted by an employer
• Fringe benefits are in cash or in kind
• Taxable fringe benefits received by rank and file are subject to basic tax
• Taxable fringe benefits received by supervisory or managerial employees are subject to fringe benefits tax (FBT), a final tax

Fixed or Variable Allowances

• Fixed or variable allowances received by public officers/private entity employees are subject to income tax
• These are also subject to creditable withholding tax on compensation income
• Examples include transportation, representation, communication, and living away from home allowances (LAFHA)

Traveling and Entertainment Expenses

• Reasonable travel and entertainment reimbursements/advances do not require substantiation or withholding if pre-computed daily and paid on assignment
• Expenses are not subject to withholding if:
  • They are for ordinary/necessary travel, representation, or entertainment in pursuit of business/profession, and
  • The employee liquidates expenses per the Tax Code Sec. 34 requirements

Premiums on Life Insurance

• Employer-paid life insurance premiums are taxable income to the employee
• This applies if the insured employee is the beneficiary

Deductible Expense of the Employer

• Any amount the employer gives to employees is a deductible expense
• This is whether classified as de minimis or fringe benefits

Retirement Benefits, Separation Pay, Pension, etc.

• Employees receive retirement benefits, separation pay, pension, and cost of living allowances (COLA)
• These are other tax-exempt income from employers

Tips and Gratuities

• Tips and gratuities paid directly to an employee by a customer are taxable income subject to basic tax

Vacation and Sick Leave Allowances

• Vacation and sick leave are vacation allowances or sick leave credits and are treated as compensation income
• An employee's salary on leave is compensation, despite the absence from work
• Monetized unutilized vacation leave credits of 10 days or less paid during the year are considered de minimis benefits
  • These are not subject to income tax and withholding tax.

Representation & Transportation Allowances (RATA)

• RATA granted to government officials/employees under the General Appropriations Act are considered reimbursements for duties performed
• Excess RATA not returned to the employer is taxable compensation income

Stipends of Resident Physicians

• Stipends for resident physicians in training programs are subject to creditable withholding tax (CWT)
• Amounts subject to CWT include fees, per diems, allowances, and other income payments not subject to withholding tax on compensation

Cost of Living Allowance (COLA)

• COLA for minimum wage earners (MWEs) is exempt from income tax
• COLA is part of the statutory minimum wage and is covered by the MWEs' income tax exemption under RA9504

Income or Gain from Stock Option Plans

• Income/gain from an employee's stock option exercise is considered additional compensation
• This is subject to withholding tax on compensation (WTC)

Business Income

• Gross income from trade/profession is business income
• It can arise from product/service sales
• Fees for professional services and real estate rents are business income
• Business income is taxed at progressive rates on net business income or income from the practice of the profession
• Gross income for manufacturing, merchandising, or mining is total sales less cost of goods sold, plus income from investments/operations

Bad Debt Recovery

• Recovery of previously written off bad debt is taxable income, if the write-off resulted in lower taxable income
• The "Tax Benefit Rule" obliges taxpayers to declare subsequent bad debt recovery as taxable income
• This applies to the extent of the tax benefit enjoyed when the bad debts were written off
• If the write-off did not reduce income tax, the recovery is not taxable income but a return of capital

Cancellation or Condonation of Debts

• Cancellation/condonation of debts can be a form of income

Applicable Tax Based on Reason for Cancellation:

• Subject to basic income tax if services were rendered by the debtor in consideration of the cancellation
• Subject to donor's tax if the creditor cancels the debt without receiving consideration, purely as an act of generosity
• Subject to 10% final tax if a corporate shareholder cancels the indebtedness

Tax Refund

• Under the Tax Benefit Rule, tax refunds are taxable if the tax was deducted from gross income when paid
• Taxes not previously allowed as deductions from gross income are not taxable when refunded
• The following tax refunds are not taxable:
  • Income Tax (except fringe benefits tax)
  • Estate Tax
  • Donor's Tax
  • Special assessments
  • Stock Transaction Tax
  • Income tax paid to a foreign country if the taxpayer claimed credit for such tax in the same year
• Tax refunds should be reported as income in the year it was received if the accounting method employed by the taxpayer is the cash method
• If the accounting method used is the accrual basis, the tax refund must be reported in the year the refund was ordered.

Gains Derived from Dealings in Property

• Gross income from property dealings (sale, barter, or exchange) includes income from property disposition (real or personal) resulting in gain or loss
• Gain from the transaction is taxable, and loss is deductible if incurred in trade, profession, or business

Applicable Taxes on Income/Gains Based on Property Type:

• Ordinary Asset: ordinary gain taxed at basic tax rates
• Capital Asset: capital gain taxed at capital gains tax; includes shares of stock not listed on the local stock exchange, real property in the Philippines, and other types of capital assets (taxed at basic tax)

Interest Income

• Generally, interests are taxable income, unless exempted by law regardless of being usurious
• Gross income from interest should arise from indebtedness
  • This is compensation for the loan of money, goods, or credits
• Interest from lending money, goods, or credits and interest earned in trade/business are subject to basic tax
• Interest income passive income from bank deposits and substitutes are subject to 20% final withholding tax
• Investment income from government securities is subject to a 20% final tax

Applicable Tax on Interest Income Based on Source:

• Arising from indebtedness other than a financial institution: basic tax
• Arising from bank deposit, deposit substitute, trust fund, mutual fund, and similar arrangements: 20%; 25% final withholding tax (FWT)
• Deposit under FCDU: 15%
• Long-term bank deposit or investment: exempt for individual taxpayers and NRA-NET

Rent Income

• Rent paid by the lessee for property use/lease is taxable income to the lessor
• It is the amount paid for the use/enjoyment of a thing (real or personal) or right

Rent Income Forms:

• Cash at a stipulated price
• Obligations of the lessor to third persons paid or assumed by the lessee (e.g., real property taxes, insurance)
• Advance payment
• Prepaid rent is reported as income in full in the year of receipt
• Security deposit applied to rental is taxable income Non-Taxable Rent: advance rentals for option money and security deposits for faithful performance of obligations

Leasehold Improvement

• Leasehold improvement is an improvement made to a leased asset
• Buildings/improvements by lessee on leased premises are taxable only if made under agreement and not removable by the lessee
• The lessor does not realize a taxable gain from leasehold improvements if fully depreciated and requiring renovations to restore condition
• Lessees may claim depreciation of improvements as a deduction from gross income over remaining lease term or life of improvements
• Lessors can report the fair market value as income using either:
  • The outright method (report fair market value upon completion)
    • or
  • The spread-out method, allocating estimated depreciation value over the lease term

Formula for Annual Income (Spread-out method):

• Annual income = Book value / Remaining term of lease

Pre-Termination of Lease

• If lease is terminated (other than a purchase by the lessee), the lessor realizes additional income
• Additional income is computed as follows:
  • FMV upon pre-termination
  • Subtract Income already recognized/reported
  • Income, year of pre-termination is the difference

Dividend Income

• Dividends are payments made by a corporation to its shareholder members
• They are the portion of corporate profits paid to stockholders (direct or indirect)
• A direct dividend is from the corporation acknowledging dividend distribution through a Board resolution
• An indirect dividend is a distribution of profits disguised as payment for services, properties, etc.

Dividends are Subject to:

• Basic tax
• Final tax
• Exemption From taxation
• Dividends from foreign corporations and share in the net income of a general professional partnership (GPP) are subject to basic tax.
• Individuals receiving dividends, inter-corporate dividends from resident foreign corporations, and shares of individuals in partnerships/joint ventures are subject to final tax
• Intercorporate dividends that domestic corporations/ resident foreign corporations receive are exempt from tax

Situs of Dividend

• From Domestic Corporations = income within
• From Foreign Corporations = within or outside

Types of Dividends

• Cash dividends are paid out of currency and taxed in the year paid, the most common method
• Property dividends are paid out in the form of a non-cash asset called dividends in kind
• Liquidating dividends are generally not dividend income but a sale/exchange of property, gain/loss is taxable/deductible
• Stock dividends are paid out as transfer from "surplus" to "capital stock"

Prizes and Winnings

• A prize recognizes and rewards actions or achievements
• Winnings are rewards/income by chance or bets

As a rule, prizes and winnings are taxable unless exempt. Exempt from Tax:

• Prizes/awards for religious, charitable, scientific, educational, artistic, or civic achievement
  • The recipient was selected without action and isn't required to render future services
• All prizes/awards to athletes in local/international competitions sanctioned by national sports associations
• PCSO/Lotto winnings not exceeding P10,000 for individual taxpayers, except NRA-NETB Subject to Basic Tax:
• Resident citizens and domestic corporations derive prizes and other winnings from sources outside the Philippines
• Prizes and winnings received by any corporations
• Prizes received by individuals from sources within the Philippines amount to less than P10,000 (except NRA-NETB). Subject to 20% Final Tax:
• Prizes received by individuals (except NRA-NETB) from sources within the Philippines exceeds P10,000
• PCSO/Lotto winnings exceeding P10,000 received by individuals except for NRA-NETB
• Other winnings from sources within the Philippines, regardless of amount (other than PCSO and Lotto winnings). Subject to 25% Final Tax:
• Prizes and other winnings received by NRA-NETB.

Pensions

• Pensions are generally subject to income tax, unless exempt under the law
• Exempted are retirement benefits received under Republic Act No. 7641
• Also, for those received by officials and employees of private firms, whether individual or corporate, with a reasonable benefit plan - There must be a duly registered retirement plan with certification - The retiring official or employee has been with the same employer for a decade - They must not be under 50 years old at retirement - They must not have benefited from such plans previously

Partner's Share in the Net Income of a General Professional Partnership (GPP)

• A General Professional Partnership (GPP) is not subject to income tax
• The partners are liable for income tax on their capacities separately and individually
• Every partner reports as gross income their distributive share

Partner's Share Income

• General Partnership (GP): dividends income is the partner’s, thus its subject to final withholding tax on passive income and not included for taxable income subject to tax
• General Professional Partnership (GPP): taxable income for a partner and included in ITR