Gross Income and Compensation

• Gross income refers to items in Sec 32 of the tax code, including all income sources unless exempt by law.

Items Included in Gross Income:

• Compensation for services
• Income from trade, business, or profession
• Gains from property dealings
• Interests
• Rents
• Royalties
• Dividends
• Annuities
• Prizes and winnings
• Pensions
• Partners' share in professional partnership income
• Gross compensation income is any remuneration for personal services from an employer-employee relationship.
• The basis of payment (piecework, percentage of profits, hourly, daily, weekly, monthly, or annually) does not determine if it's compensation.
• Compensation is determined only when the service is rendered.
• Compensation income, including overtime, holiday, night shift, and hazard pay, earned by Minimum Wage Earners (MWE) with no other taxable income is non-taxable and not subject to withholding tax.
• An employer-employee relationship exists when the person receiving services has the right to control the individual performing the services, regarding both the result and the details of the work.
• Remuneration is compensation even if the employer-employee relationship no longer exists when payment is made.
• Taxable compensation income is based on gross income less applicable exemptions.
• No business or personal expenses are deductible.
• Compensation income rules apply only to resident citizens, resident aliens, and non-resident aliens engaged in business in the Philippines.
• It doesn't apply to non-resident aliens not in business or to corporations, estates, and trusts.

Classification of Gross Compensation Income:

• Basic Salary refers to earnings received periodically for regular work other than manual labor, such as a monthly salary.
• Wages are earnings received at specified intervals, such as hourly, daily or weekly, and backwages are subject to income tax and withholding tax.
• Honoraria are given in recognition of services discouraging a fixed fee, like a guest lecturer's honorarium.
• Fixed or variable allowances for transportation, representation, COLA, etc., received by public or private employees in addition to regular compensation are subject to withholding tax.
• Amounts specifically for travelling, representation, and other necessary expenses incurred by the employee are not compensation subject to withholding tax if they are ordinary, necessary, and the employee is required to liquidate expenses as per Sec. 34 of the tax code.
• Excess expenses over advances are taxable income if not returned.

Rulings on Allowances:

• Transportation and cell phone allowances for call center employees are not taxable.
• This includes fixed monthly transportation allowances and mobile phone allowances for supervisors, managers, and directors on call 24/7.
• Transportation and Night Shift Allowances for night shift employees and Meal/Out-of-Town Allowances for field work are not subject to FBT, income tax, and withholding tax.
• A daily taxi/transportation allowance for BPO employees working overtime or starting shifts at night is exempt from tax.
• Taxi/transportation allowances precomputed and paid to employees on assignment are not subject to substantiation or withholding tax.
• Commission is a percentage of total sales or quota attained as an incentive.
• Fees are paid to an employee for services rendered, including director's fees and fees for public officials for official duties above regular salaries. Legal fees paid by a union for its president are compensation.
• Marriage fees, baptismal offerings, and contributions to clergy are considered compensation.
• Tips and gratuities paid directly to an employee (not accounted for by the employee) are taxable income, without withholding tax.
• Hazard or Emergency pay is an additional payment for workers exposed to danger, like night differential pay. Overtime, night shift differential, and holiday pay for minimum wage earners are non-taxable if the MWE has no other reportable income.
• Retirement pay is a lump sum payment to an employee retiring after considerable service.
• Retirement pay is generally taxable except for SSS or GSIS retirement pays, or retirement pay due to old age if the retirement program is approved by the BIR Commissioner, is a reasonable benefit plan implemented fairly for all employees, and the retiree has been employed for 10 years, is at least 50 years old at retirement, and has availed of it for the first time.
• Separation pay is taxable if voluntary.
• It is not taxable if involuntary, such as death, sickness, disability, company reorganization/merger, or company bankruptcy.
• When a company is at the brink of bankruptcy, debts are paid in the order of BIR, then employees, then creditors.
• Amounts received due to death, sickness, disability, or causes beyond the employee's control are tax-exempt.
• Separation must not be asked for or initiated by the employee.
• Amounts from involuntary separation remain exempt even if the employee had less than 10 years of service or is below 50.
• Payments due to dismissal are compensation, regardless of legal obligation.
• Pension is a regular allowance paid due to retirement, death, past services, work, age, or injury, and is taxable unless otherwise stated or the BIR approves the private pension plan.

Vacation and Sick Leave:

• Paid or availed vacation/sick leave is taxable compensation income.
• Monetized value of unutilized vacation leave credits of 10 days or less paid to private employees is not subject to tax or withholding tax.
• Monetized value of vacation/sick leave credits paid to government officials is not subject to income tax or withholding tax.
• Thirteenth month pay and other benefits are not taxable if the total is P82000 or less; amounts exceeding P82000 are taxable.
• Fringe benefits are goods, services, or benefits provided by an employer in addition to basic salaries.
• De Minimis benefits are privileges of relatively small value and are not considered taxable compensation.
• Overtime Pay is a premium for working beyond regular hours and is included in gross salary.
• Back pay and overtime pay are considered compensation.
• Profit sharing is a proportionate share in business profits received by the employee in addition to wages.
• Awards for Special Services received by an employee are compensation.
• Beneficial Payments, such as an employer paying an employee's income tax, are additional compensation income.
• Other forms of compensation include compensation paid in kind.
• Taxes are generally paid in money.
• Insurance premium paid by the employer for the employee's insurance coverage where the heirs of the employee are the beneficiaries is part of the employee's income.
• Compensation paid in stock is treated as if the corporation sold the stock at market value and paid in cash.
• Fair market value of stock at the time the service is rendered determines the tax.
• A stock option is a privilege to key employees to avail of the corporation's shares at a future date for a certain price.
• If the market price is greater than the option price when a company issues a stock option, the difference is compensation income at the date of grant.
• If stocks are sold, the excess of the market price at the date of sale over the market price at the date of grant is a capital gain.
• Cancellation of debt may be income, gift, or capital, depending on circumstances.
• If a creditor cancels debt to benefit the debtor without consideration, it is a gift.
• If a corporation forgives debt, it is a dividend income to the stockholder.
• If a debtor performs services and the creditor cancels the debt in consideration, the debtor realizes income to the amount of debt canceled.
• Premiums paid by the employer for life insurance where the employee's family is the beneficiary constitute taxable income.
• Income tax paid by the employer for the employee is taxable based on the amount of tax paid.
• Under the Convenience of the Employer's Rule, allowances in kind are non-taxable if necessary for job performance.

Living Quarters and Meals:

• When living quarters are furnished in addition to cash salary, the rental value is reported as income.
• If living quarters or meals are furnished for the employer's convenience, the value isn't included in compensation.
• Unless solely for the employer's benefit, the rental value of living quarters is compensation to the extent of reasonable needs.
• Excess expenses are the corporation's.
• The value of board and lodging furnished by an employer is ordinarily taxable.
• Exclusion for meals is allowed only when meals are furnished or subsidized for the employer's convenience, incidental to work requirements.

Remuneration for Casual Labor:

• Remuneration for casual labor not in the course of an employer's trade/business is not compensation.
• Casual labor is occasional, incidental, or regular.
• "Not in the course of the employer's trade or business" means labor that doesn't promote the trade or business.
• Remuneration for casual labor rendered in the course of the employer's trade or business is compensation.
• Remuneration for casual labor performed for a corporation is compensation.
• Business is any commercial activity for livelihood or profit and includes trading, manufacturing, etc.
• Profession is specialized training engaged in for livelihood or profit and is generally a service business.

Gross Income from Business:

• Manufacturing
• Merchandising
• Servicing
• Farming
• Long-term contract
• For manufacturing, merchandising, or mining, gross income is gross sales less returns, discounts, and cost of goods sold, plus any investment income and outside sources.
• Subtractions shouldn't be made for depreciation, depletion, selling expenses, losses, or items not ordinarily used in computing the cost of goods sold.
• For taxpayers selling services, gross income is gross receipts less returns.
• The cost of goods sold includes all business expenses for producing the merchandise to bring them to their present location and use.
• Cost of sales is deducted from net sales to calculate gross income.
• Cost of Goods Manufactured and Sold includes costs of finished goods sold, i.e. raw materials, direct labor, manufacturing overhead, freight cost, insurance premiums, etc.
• Cost of goods sold of trading or merchandising concern refers to the invoice cost, plus import duties and freight incurred in transporting the goods to the place where they are actually sold, including insurance while in transit.
• For minimum corporate income tax, the cost of service of a servicing concern also includes Salaries, Benefits of personnel/consultants directly rendering the service, Cost of facilities directly utilized in providing the service, Cost of supplies, banking interest expense.

Telegraph and Cable Services

• For a foreign corporation, include income from services within the Philippines only.
• Specifically, the income may be derived from the following: gross revenues derived from messages originating in the Philippines and amounts received by the company collected abroad on collect messages originating in the Philippines
• Rental Income refers to earnings from leasing real estate or personal property.
• Includes regular payments and other obligations paid by the lessee on behalf of the lessor.
• Rental income is determined by the gross receipts for the year (earned and unearned under accrual basis).

Prepaid rental

• If the advance payment is a prepaid rental received without restriction, the entire amount is taxable in the year it is received.

Security Deposit with Restriction

• If the advanced payment is a security deposit which restricts the lessor as to its use, then such amount should be excluded in the determination of rental income

Security Deposit with an Acceleration Clause

• If the advanced payment is a loan deposit, or option money, such advance payment is not an income to the the lessor. But if the the Lessee violates the terms of the contract, it inures to the lessor.

Income from Leasehold Improvement

• when the lessee erected or built permanent improvements on the leased property which will become the property of the lessor upon the expiration of the lease, the value of the improvements should be reported as income either outright or spread out method:

Outright method

• the income from leasehold improvement shall be recognized when the improvement is completed.

Spread out method

• the estimated book value of the leasehold improvement at the end of the lease is spread over the term of the lease

Termination of the Contract of Lease

• Where there is an immovable improvement made by the lessee on the lease property and the termination of the contract of lease is made before the expiration of the lease term, the following rules should regulate the circumstances

If the improvement is destroyed BEFORE the expiration of the lease

• the lessor is entitled to deduct a loss for the year, when such destruction takes place, the amount previously reported as income less any salvage value, to the extent that such loss was not compensated for by insurance

If for any reason other than a bona fide purchase from the lessee by the lessor

• the lessor receives additional income for the year if the value of improvement exceeds the amount of income already reported
• Gains from Dealings in Property This refers to the excess of amount received by the taxpayer over the determined value of the property he has disposed of
• Passive income a final tax is imposed upon gross passive income of citizen and resident aliens
• An income is considered passive if the taxpayer merely waits for it to be realized

Yield from deposit substitutes and trust fund

• Deposit substitute - is a debt instrument issued by the bank to borrow money from the public other than from the client's deposit
• Trust fund – is any estate, especially stock, securities, or money which is held in trust by a person in behalf of another person Both deposit substitute and trust fund yield earnings that are to be treated as interest income
• Interest income is an earning derived from depositing or lending of money, goods, or credits; Unless exempted by law, whether or not usurious, is subject to income tax
• For individuals, except non-resident aliens not engaged in trade or business in the Philippines, interest income from long-term deposit or investment shall be exempt from income tax, provided that for the certificate must have a maturity period of not less than five years and in denominations of P10,000
• Stock dividends are not subject to tax

Royalty

• In general, includes those which are derived from natural resources or products such as coal, gas, oil, Royalties on books, literary works and musical composition are royalty income subject to 10% final tax
• Dividend income is a form of earnings derived from the distribution made by a corporation out of its earnings or profits and payable to its stockholders
• Pure stock dividends is tax exempt
• Cash or property dividend is subject to final tax if received by an individual or non-resident corporation from a domestic corporation subject to income tax
• Dividends excluded from rules 1,2 and 3 are included in the computation of the taxable income and income tax at the end of the year
• Cash dividend and valuation is the extent of amount of money received by the stockholder
• Stock dividends are not subject to tax except when there is an option to take cash, when some stockholders exercised the option, And when the exercise of option resulted in a change in the stockholder
• Redemption of Stock Dividend If the corporation cancels or redeems stock issued as a dividend equivalent to the distribution of a taxable dividend, the amount is considered taxable income
• Stock dividends of a different class are not considered income
• Scrip Dividend – is issued in the form of promissory note and taxable to the extent of its fair market value.
• Indirect Dividends are dividends representing payments or rights received by the taxpayer, which are really dividends.
• As a rule, the excess amount of liquidating dividends over cost of shares surrendered is taxable.
• Prize represents remuneration for an effort reflecting one's superiority, like prize money of a boxing contest
• Winnings depends on chance such as winnings from gambling, lottery or raffle ticket
• Prizes are subject to final tax of 20% except if the amount of the prize is ten thousand (P10,000)
• The partner's share in the distributive profit of a professional partnership represents his gross income

Other Sources of Income

• Bad debt recovery
• Tax refund or credit
• Damages recovery
• Annuities
• Income from whatever source
• If a taxpayer deducted an item on his income tax return and enjoyed a tax benefit, the recovered item is recovered as gross income
• Bad debts are worthless amounts to be written off during the taxable year and the debt must be charged off during the taxable year
• If the tax paid is deductible, refund is taxable
• If the part of annuity payment represents interest, then it is TAXABLE income. If the annuity is a return of premium, it is NOT TAXABLE
• Income from whatever sources - inclusion of all income not expressly exempted within class of taxable income under the laws irrespective illegal income is taxable even though he is obligated to return it when discovered
• Moral turpitude is not a touchstone of taxability
• If the embezzler reaps the fruit of his crime is in receipt of income