Tax Chapter 14 - Regular Income Taxation: Individuals PDF

# Chapter 14 - Regular Income Taxation: Individuals ## Chapter Overview and Objectives All tax rules relevant to income taxation of individuals are already covered in previous chapters. This chapter aims to provide an integration of all income tax rules which are specifically relevant to individua...

# Chapter 14 - Regular Income Taxation: Individuals ## Chapter Overview and Objectives All tax rules relevant to income taxation of individuals are already covered in previous chapters. This chapter aims to provide an integration of all income tax rules which are specifically relevant to individual taxpayers in order to simulate a closer to reality depiction of individual income taxation in practice. After this chapter, readers are expected to demonstrate mastery on the following: - Determination of tax under the regular income tax option - Determination of tax under the 8% income tax option - Preparation of quarterly and consolidated or adjustment return - Rules relevant to taxable estates and trusts - Rules on installment payment of the regular tax ## Individual Income Taxation ### The Regular Income tax for Individuals The income tax of individuals is determined through the following tax table: #### Year 2018 to Year 2022 | Taxable income | Tax due | |:---|:---| | P250,000 and below | None (0%) | | Above P250,000 to P400,000 | 20% of excess above P250,000 | | Above P400,000 to P800,000 | P30,000 + 25% of excess over P400,000 | | Above P800,000 to P2,000,000 | P130,000 + 30% of excess over P800,000 | | Above P2,000,000 to P8,000,000 | P490,000 + 32% of excess over P2,000,000 | | Above P8,000,000 | P2,410,000 + 35% of excess over P8,000,000 | #### Year 2023 Onwards | Taxable income | Tax due | |:---|:---| | P250,000 and below | None (0%) | | Above P250,000 to P400,000 | 15% of excess above P250,000 | | Above P400,000 to P800,000 | P22,500 + 20% of excess over P400,000 | | Above P800,000 to P2,000,000 | P102,500 + 25% of excess over P800,000 | | Above P2,000,000 to P8,000,000 | P402,500 + 30% of excess over P2,000,000 | | Above P8,000,000 | P2,205,500 + 35% of excess over P8,000,000 | ## Taxpayers Subject to Progressive Income Tax The progressive income tax for individuals covers the following: 1. **Citizens** - Resident citizen - Non-resident citizen 2. **Aliens** - Resident alien - Non-resident alien engaged in business 3. **Taxable estate** 4. **Taxable trust** ## Classification of Individual Income Taxpayers For purposes of the regular tax, individual income taxpayers are classified as: 1. Pure compensation income earner 2. Pure business or professional income earner 3. Mixed income earner ## Pure Compensation Earner The compensation income of employees, except minimum wage earners, is subjected to withholding tax on compensation. Every employer is mandatorily required to deduct the withholding tax from the compensation income of their employees. ### Treatment of the Withholding Tax on Compensation 1. **Full payment** – if the employee has no other income and the tax is correctly withheld 2. **Tax credit** - if the employee has other taxable income or if the tax is not correctly withheld ### Employees with no other Income If the employee has no other taxable income, he may avail of the substituted filing system. Under this system, the withholding tax on compensation is considered enough evidence of tax compliance of the employee, provided that the employer withheld the correct tax. ### Conditions of the Substituted Filing System 1. The employee received purely compensation income during the year. 2. The employee received the income from only one employer in the Philippines during the taxable year. 3. The amount of tax due from the employee at the end of the year equals the amount of tax withheld by the employer (i.e., correct tax is withheld). 4. The employee's spouse also complies with all 3 conditions stated above. 5. The employer files the annual information return (BIR Form No. 1604-CF). 6. The employer issues BIR Form No. 2316 to each employee. ### Employees who do not meet the conditions of the substituted filing system shall file the annual or final adjustment return not later than April 15 of the following year and claim Form 2316 as tax credit. ## Consolidated or Adjustment Return Consolidated or adjustment return is needed when: 1. Correct tax is not withheld 2. Employee or his spouse has other income ### Correct Tax Due Not Withheld by Employer The correct tax due of the employee will least likely to be withheld by the employer in the following cases: - Concurrent employment - Successive employment during the year - Incurrence of error by the employer An annual return needs to be filed to adjust the tax due to the correct amount of tax. This is referred to as an adjustment return. The employee shall claim Form 2316 as tax credit and pay residual tax due or claim excess withheld amount as tax credit or tax refund. ### Illustration 1: Concurrent employment Vic Luna is both employed in Yousee Company and in Youbee Company. He has the following income and withheld tax in 2023: | | Yousee | Youbee | |---|---|---| | Taxable compensation income | P 450,000 | P 350,000 | | Withheld tax | P 42,500 | P 20,000 | Mr. Estoque's consolidated income tax shall be computed as follows: - Taxable compensation income (P450,000+P350,000) | P 800,000 - Income tax due, per individual tax table | P 102,500 - Less: Tax withheld by employers (P42,500+P20,000) | P 62,500 - Income tax payable or (refundable) | P 40,000 ### Illustration 2: Successive Employment During the year, Zeus resigned from Blue Moon Company and transferred employment to Gagamba Company. The following were his income: | | Blue Moon | Gagamba | |---|---|---| | Taxable compensation income | P 300,000 | P 400,000 | | Tax withheld from compensation | P 10,000 | P 30,000 | Zeus shall file a consolidated return covering his total 2020 income from both employment and pay the residual tax as follows: - Taxable compensation income (P300,000 + P400,000) | P 700,000 - Income tax due, per individual tax table | P 82,500 - Less: Tax withheld by both employers | P 40,000 - Income tax payable or (refundable) | P 42,500 ### Illustration 3: Employer error In 2022, Jeff's employer withheld a total of P 56,000 out of his P460,000 taxable compensation income. Since the tax withheld is erroneous, Jeff shall file an annual adjustment return and pay residual tax due or claim refund or tax credit for excess withholding, as follows: - Taxable compensation income | P 460,000 - Income tax due, per individual tax table | P 45,000 - Less: Tax withheld by employers | P 56,000 - Income tax payable or (refundable) | (P 11,000) Jeff shall use BIR Form 1700 as adjustment return. ## Employees Has Other Taxable Income Employees other income subject to regular tax may come from: - Casual sources - Engagement in business or practice of a profession If the employee has other taxable income, the employee is mandatorily required to file an annual income tax return to incorporate other income sources in his return. This is referred to as a consolidated income tax return. The consolidated income tax return may either be: - BIR Form 1700 – if the employee is not engaged in business or profession - BIR Form 1701 for mixed income earners – if the employee is also engaged in business and or profession The withholding tax on compensation (BIR Form 2316) given by the employer shall be claimed as tax credit. ### Illustration - With other casual income Mr. Sung Ki is a sales executive. He received the following compensation and benefits from his employer: - Gross compensation income | P 987,000 - Exempt benefits | P 84,000 - Fringe benefits (paid personal vacation) | P 81,000 - Mandatory deduction for SSS, PhilHealth, HDMF | P 40,000 - Total withholding tax deducted under Form 2316 | P 125,750 He also derived the following other income: - Interest income from corporate bonds, net of 15% withholding tax | P 76,500 - Interest income from bank deposits, net of 20% final tax | P 16,000 - Gain on sale of arts collection (held 3 years) | P 124,000 - Total income | P 216,500 Mr. Ki shall file BIR Form 1700 to include his other income subject to regular tax: - Interest income from bonds (P76,500/85%) | P 90,000 - Gain on sale of arts collection (P124,000 x 50% - long term) | P 62,000 - Other income | P 152,000 **Note:** The fringe benefits of an executive - a managerial employee and the interest income from deposits are subject to final tax. These are excluded in gross income subject to regular tax. The associated final taxes are not creditable. The tax credits shall be: - Withholding tax on compensation (Form 2316) | P 125,750 - Withholding tax on the interest (P90K x 15% under Form 2307) | P 13,500 Mr. Ki's taxable income shall be computed as: - Gross compensation income | P 987,000 - Less: Mandatory deductions | P 40,000 - Exempt benefits | P 84,000 | P 124,000 - Taxable compensation income | P 863,000 - Add: Other income subject to regular tax | P 152,000 - Taxable income | P1,015,000 Mr. Ki's income tax still due shall be computed as: - Income tax due | P 156,250 - Less: Tax credit - Form 2316 | P 125,750 - Form 2307 | P 13,500 | P 139,250 - Income tax still due | P 17,000 The consolidation procedures of employees engaged in business or practice of a profession will be discussed under mixed income earners. ## Pure Business and/or Professional Income Earner Individual taxpayers engaged in business or practice of profession shall file quarterly income tax returns (BIR Form 1701Q) and an annual tax return: ### Quarterly Tax returns | Quarterly Tax Returns | Deadline | |:---|:---| | 1st Quarter ITR - 1701Q | May 15 of the same calendar year | | 2nd Quarter ITR – 1701Q | August 15 of the same calendar year | | 3rd Quarter ITR - 1701Q | November 15 of the same calendar year | | Annual ITR - 1701A | April 15, next year | The taxable income from business or profession may be computed using: - Itemized deductions - Optional standard deduction ### Illustration 1 - Itemized deduction Mrs. Macipag, a self-employed taxpayer, had the following quarterly income details in 2023: | | Jan.-March | April-June | July-Sept | Oct.-Dec | |:---|:---|:---|:---|:---| | Gross receipts | P 600,000 | P 520,000 | P 550,000 | P 580,000 | | Less: Cost of services | P 120,000 | P 200,000 | P 250,000 | P 270,000 | | Gross income | P 480,000 | P 320,000 | P 300,000 | P 310,000 | | Less: Expenses | | | | | | - Business expenses | P 100,000 | P 130,000 | P 120,000 | P 140,000 | | - Personal expenses | P 60,000 | P 63,000 | P 58,000 | P 85,000 | | Total | P 160,000 | P 193,000 | P 178,000 | P 225,000 | | Net income | P 320,000 | P 127,000 | P 122,000 | P 85,000 | | Withholding tax | P 4,000 | P 10,000 | P 15,000 | P 14,000 | Her quarterly and annual taxable income and tax due shall be computed on her cumulative year-to-date taxable income as follows: | | 1st Qtr. | 2nd Qtr. | 3rd Qtr. | Annual ITR | |:---|:---|:---|:---|:---| | Gross receipts | P 600,000 | P 1,120,000 | P 1,670,000 | P 2,250,000 | | Less: Cost of sales | P 120,000 | P 320,000 | P 570,000 | P 840,000 | | | P 480,000 | P 800,000 | P 1,100,000 | P 1,410,000 | | Less: Deductions | | | | | | - Taxable net income | P 100,000 | P 230,000 | P 350,000 | P 490,000 | | | P 380,000 | P 570,000 | P 750,000 | P 920,000 | ### Illustration 2 - Optional standard deduction Let us assume the same data in the preceding problem, except that the taxpayer opted to use the optional standard deduction in 2023. The quarterly and annual taxable income and tax due shall be computed as follows: | | 1st Qtr. | 2nd Qtr. | 3rd Qtr. | Annual ITR | |:---|:---|:---|:---|:---| | Gross receipts | P 600,000 | P 1,120,000 | P 1,670,000 | P 2,250,000 | | Less: OSD - 40% | P 240,000 | P 448,000 | P 668,000 | P 900,000 | | Taxable net income | P 360,000 | P 672,000 | P 1,002,000 | P 1,350,000 | | | 1st Qtr. | 2nd Qtr. | 3rd Qtr. | Annual ITR | |:---|:---|:---|:---|:---| | Income tax due | P 16,500 | P 76,900 | P 153,000 | P 240,000 | | Less: Tax credits | | | | | | | | | | | | - CWT this quarter | P 4,000 | P 10,000 | P 15,000 | P 14,000 | | - CWT prior quarters | 0 | P 4,000 | P 14,000 | P 29,000 | | Total credits | P 4,000 | P 14,000 | P 29,000 | P 43,000 | | | P 12,500 | P 62,900 | P 124,000 | P 197,000 | | Less: Estimated tax paid in prior quarters | 0 | P 12,500 | P 62,900 | P 124,000 | | Income tax still due | P 12,500 | P 50,400 | P 61,100 | P 73,000 | ### Excess Quarterly Estimated Tax The excess quarterly estimated tax payments over the quarterly tax due may, at the option of the taxpayer, be carried forward to quarters of the succeeding taxable year or claimed through tax refund. The option must be indicated in the annual adjustment return. Once the option to carry-over is made, it becomes irrevocable for that period. #### The option to refund The option to refund may be in the form of cash or a tax credit certificate. If the option to refund is selected, the excess refundable amount should not be carried over as tax credit to the succeeding quarters of the following year. ## Mixed Income Earner The compensation income of mixed income earners will be subjected to the withholding tax on compensation by their employers. Mixed income earners would report their business or professional income on a quarterly basis under Form 1701Q. The compensation income shall not be reported in the quarterly return. It shall be included only in the annual consolidated return. Mixed income earners shall use BIR Form 1701. ### Illustration To facilitate our discussion, let us assume the same data in the previous illustration, except that Mrs. Macipag is also employed with the following income in 2023: | | Jan. - March | April - June | July - Sept. | Oct. - Dec. | |:---|:---|:---|:---|:---| | Taxable compensation | P 250,000 | P 260,500 | P 245,250 | P 231,250 | | Withholding tax on compensation (Form 2316) | | | | P 93,750 | #### Business | | Jan. - March | April - June | July - Sept. | Oct. - Dec. | |:---|:---|:---|:---|:---| | Gross income | P 480,000 | P 320,000 | P 300,000 | P 310,000 | | Itemized deductions | P 100,000 | P 130,000 | P 120,000 | P 140,000 | | Net income | P 380,000 | P 190,000 | P 180,000 | P 170,000 | | | Jan. - March | April - June | July - Sept. | Oct. - Dec. | |:---|:---|:---|:---|:---| | Form 2307s | P 4,000 | P 10,000 | P 15,000 | P 14,000 | #### Quarterly tax Mrs. Macipag shall report her quarterly income from business or profession and pay the same quarterly income tax due as computed in the previous illustration: | | Jan. - March | April - June | July - Sept. | Annual ITR | |:---|:---|:---|:---|:---| | Quarterly income tax due | P 19,500 | P 56,500 | P 92,500 | ??? | The taxable income of Mrs. Macipag for the year shall be computed as: - Taxable compensation income | P 987,000 - Gross Income | P 1,310,000 - Less: Deductions | P 490,000 - Taxable income - business | P 820,000 - Total taxable income | P 1,807,000 Mrs. Macipag shall file BIR Form 1701 for her consolidated income. Her annual income tax still due shall be computed as: - Income tax due | P 354,250 - Less: Tax credit - WH tax on compensation (Form 2316) | P 93,750 - Expanded withholding tax (Form 2307s) | P 43,000 - Estimated tax payments (Form 1701Qs) | P 63,500 | P 200,250 - Income tax still due | P 154,000 ## The 8% Income Tax Option The TRAIN law introduced a new tax scheme for individual taxpayers - the 8% optional income tax. The option to be taxed at 8% must be indicated in the first quarter income tax return or in the first quarter percentage tax return. When made, the option shall be irrevocable for the calendar year. ### Nature: 1. A bundled tax – it is in lieu of: - Regular income tax, determined through the income tax table - 3% general percentage tax 2. An annual option - It is valid for as long as the taxpayer remained as a non-VAT taxpayer during the year. It will be invalidated in favor of the regular income tax once the taxpayer becomes a VAT taxpayer during the year. 3. Paid quarterly and annually ### Scope: - Pure business or professional income earners - Mixed income earners ## Business Tax: A Basic Overview Aside from income tax, individuals engaged in business or exercise of a profession are also required to pay a business tax which is either a 3% percentage tax or a 12% value added tax (VAT). ### Types of business taxpayers: 1. **Exempt businesses** – not subject to VAT or percentage tax - Examples: - Businesses selling agricultural products in original state - Agricultural contract growers - Book publishers or bookstores 2. **Business specifically subject to other percentage taxes** - not subject to VAT but subject to percentage tax of various rates - Examples: - Common carriers by land, such as taxi, jeepney, bus and car for hire - Operators of cockpits, cabarets, clubs, jai-alai or horse race track 3. **Vatable businesses** – other businesses - Vatable businesses either pay: - 12% value added tax - if their annual sales exceed P3,000,000 or when they registered as VAT taxpayers - 3% general percentage tax - if their annual sales do not exceed the P3,000,000 and did not opt to voluntary register as VAT taxpayers Business taxation is an advanced tax topic which will be discussed under Business & Transfer Taxation by the same author. Normally, businesses or professional practitioners start small as non-VAT taxpayers. As their business or practice gains traction and reach the P3M VAT threshold, they are mandatorily required to register as VAT taxpayers. ### Covered businesses: Only vatable businesses who are below the P3M annual VAT threshold and did not register as VAT taxpayer can opt to be taxed under the 8% income tax. Thus, the option is not available to: - VAT-registered business taxpayers - VAT-exempt business taxpayers such as: - Exempt businesses - Businesses specifically subject to other percentage taxes - Individuals receiving income not subject to business tax, such as: - Partners receiving share in net income of a general professional partnership - Co-owners receiving share of income in co-owned properties - Venturers receiving share in net income of an exempt joint venture - Heirs or beneficiaries of trust receiving income distribution from estates or trusts ### Tax obligations of individual non-VAT taxpayers: | | Regular tax option | 8% Income tax option | |:---|:---|:---| | Regular income tax | 3 quarterly 1701Qs and 1 annual 1701 or 1701A | 3 quarterly 1701Qs and 1 annual 1701 or 1701A | | Percentage tax | 4 quarterly 1551Q | None | VAT-registered taxpayers pay VAT and regular income tax. ## Tax basis: The 8% optional income tax shall be based upon the gross sales or gross receipt of the individual taxpayer that is subject to 3% percentage tax. Other income subject to regular tax are added to the basis. ## Pure Business or Professional Income Earner For pure business or professional income earners, the use of the 8% income tax would effectively deny the individual taxpayer of his P250,000 annual income exemption, the same being embedded in the regular tax table. Due to this, the 8% income tax shall be computed from the basis net of P250,000. ### Illustration Assume a taxpayer who is purely engaged in business had sales of P2,000,000, net of P50,000 sales discounts, P100,000 other income subject to regular tax and expenses of P 840,000. The 8% income tax would be computed as: - Net sales/receipts/revenues/fees | P 2,000,000 - Add: Other non-operating income | P 100,000 - Total taxable income | P 2,100,000 - Less: Annual exempt income | (P 250,000) - Net total | P 1,850,000 - Multiply by: Optional income tax rate | 8% - Tax due | P 148,000 ## Mixed Income Earner Compensation income is not subject to business tax. Hence, it cannot be subjected to the 8% income tax. Due to this, the income tax due from compensation shall be separately determined using the income tax table while the 8% income tax from the business or profession shall be separately computed. For this purpose, the classification rule as discussed in prior chapters must be observed. Since the use of the income tax table in computing the tax due from compensation effectively allowed the taxpayer claim of P250,000 annual income exemption as embedded in the tax table, there will be no more P250,000 deduction allowable against the basis of the 8% income tax. Furthermore, if the amount of compensation income does not exceed P250,000, the unutilized deduction cannot be deducted against business income since the TRAIN law did not contemplate a deduction cross-over. ### Illustration 1 A mixed income earner realized P920,000 from compensation, P2,000,000 in sales, P100,000 other income subject to regular tax and incurred P480,000 in expenses The income tax due under the 8% income tax option shall be computed as: | | Income | Tax due | |:---|:---|:---| | Taxable compensation income | P 920,000 | | | Less: Lower tax bracket in tax table | P 800,000 | | | Residual income | P 120,000 | P 102,500 | | Multiply by: Incremental tax rate | 25% | P 30,000 | | Tax due - compensation income | | P 132,500 | | | | | |:---|:---|:---| | Gross sales or gross receipts | | P 2,000,000 | | Add: Other non-operating income | | P 100,000 | | Total | | P 2,100,000 | | Multiply by: Optional income tax rate | | 8% | | Tax due - business | | P 168,000 | | Total tax due | | P 300,500 | ### Illustration 2 A mixed income earner realized P2,000,000 in sales, P100,000 in other income subject to regular tax and earned P150,000 compensation from part-time employment. | | Income | Tax due | |:---|:---|:---| | Taxable net income | P 150,000 | | | Less: Lower tax bracket in tax table | P 250,000 | | | Excess | (P 100,000) | 0 | | Tax due - compensation income | | 0 | | | | | |:---|:---|:---| | Gross sales or gross receipts | | P 2,000,000 | | Add: Other income subject to regular tax | | P 100,000 | | Total | | P 2,100,000 | | Multiply by: Optional income tax rate | | 8% | | Tax due - business | | P 168,000 | | Total tax due | | P 168,000 | **Note:** The P100,000 excess of P250,000 over the compensation income cannot be deducted against the basis of the 8%. No deduction cross-over is allowed. ## Integrated Illustration ### Integrated Illustration 1 – Pure business or professional income earner Mr. Cardenas, a proprietor of a furniture shop, recorded the following income statement during the year: - Net sales of finished goods, net of P 18,000 CWTS | P 2,382,000 - Sales of scraps and trimmings | P 200,000 - Total Sales/Revenues/Receipts/Fees | P 2,582,000 - Less: Cost of sales or services | P 1,200,000 - Gross Income from Operations | P 1,382,000 | | | |:---|:---| | Add: Other income | | | - Dividend income | P 12,000 | - Gain from sale of stocks, net of capital gains tax | P 68,000 | - Interest income from deposits | P 16,000 | - Gain on sale of machinery held for 6 years | P 40,000 | - Gain on sale of bonds held for 2 years | P 20,000 | - Interest income from bonds | P 14,000 | Total Income | P 170,000 | | P 1,552,000 ### The Regular Tax Option The taxable net income of Mr. Cardenas shall be computed as follows: - Net Sales/Revenues/Receipts/Fees (P2,382K + P18K + P200K) | P 2,600,000 - Less: Cost of sales or services | P 1,200,000 - Gross Income from operation | P 1,400,000 - Less: Allowable deductions (Business expenses) | P 600,000 - Net income | P 800,000 - Add: Non-operating income - Gain on sale of machinery | P 40,000 - Gain on sale of bonds (P20K x 50% - long-term) | P 10,000 - Interest income from bonds | P 14,000 - Taxable net income | P 864,000 ### Taxes to pay **a. Regular income tax** - Taxable net income | P 864,000 - Less: Lower limit of the income bracket where the taxable income qualifies | P 800,000 - Excess | P 64,000 - Multiply by: bracket marginal rate | 25% - Income tax due | P 16,000 - | P 118,500 **b. 3% business tax** - Net Sales/Revenues/Receipts/Fees | P 2,600,000 - Multiply by: Percentage tax rate | 3% - Total percentage tax due | P 78,000 - Total taxes under the regular tax option | P 196,500 The regular income tax would be paid in three quarterly tax filing (1701Q) and an annual income tax return (1701). The 3% percentage tax will be paid in four quarterly percentage tax returns (2551Q). ### The 8% Income Tax Option Under the 8% income tax option, he would pay the following: - Total Sales/Revenues/Receipts/Fees | P 2,600,000 - Add: Non-operating income subject to regular tax - Gain on sale of machinery | P 40,000 - Gain on sale of bonds (P20K x 50% - long-term) | P 10,000 - Interest income from bonds | P 14,000 - Total taxable income | P 2,664,00