Understanding Income Tax Schemes Available for Self Employed/Professional
In 2018, the government, in an attempt to simplify Philippine Taxation applied the TRAIN law. It modified several provisions in our tax code as well as produce clarifications on some provisions therein. Undoubtedly, one of the major and under-appreciated modifications is the use of the 8% preferential rate. This is because the implementing guidelines, regulations, and clarifications that govern the use of the 8% were not understood by the prospective taxpayers who may avail of the preferential rate.
Below is an illustration to further our understanding on the already-effective TRAIN law with respect to income earned by self-employed individual and/or practice of profession.
| Annual Gross Income | ₱1,000,000 | ||
| Allowed Reduction | ₱250,000 | ||
| Itemized Deductions | ₱500,000 | ||
| 8% | Graduated Rates (itemized) |
Graduated Rates (Optional Standard Deduction) |
|
| Gross Income | ₱1,000,000 | ₱1,000,000 | ₱1,000,000 |
| Itemized Deduction | - | ₱500,000 | - |
| Special Deduction (OSD @ 40%) | - | - | -₱400,000 |
| Allowed Reduction | ₱250,000 | ₱250,000 | ₱250,000 |
| Taxable Income | ₱750,000 | ₱250,000 | ₱350,000 |
| Income Tax Due | ₱60,000 | ₱50,000 | ₱70,000 |
| Percentage Tax Due | ₱0 | ₱30,000 | ₱30,000 |
| Tax Withheld by Customer @5% | ₱50,000 | ₱50,000 | ₱50,000 |
| Total Taxes Due for the Year | ₱10,000 | ₱30,000 | ₱50,000 |
The illustration above can be interpreted in many ways. Simply put, the 8% preferential rate allows us to get lower tax dues and less tedious job on monitoring our accounting and tax details. On the other hand, graduated rates are classified further based on the amount of deduction tax payers are allowed to use. Generally, itemized deduction allows us to freely use any amount related to our business and operating expenses as deductions provided that all expenses are properly substantiated with necessary documents (i.e., sales invoice and official receipts) and in accordance with BIR’s invoicing requirements and other related regulations. The use of optional standard deduction allows us to deduct 40% of the gross income in lieu of itemized deductions. This means that the amount equivalent to 40% in lieu of itemized deductions needs no substantiation.
While the illustration above shows that 8% preferential rates leads to the lowest tax dues, in some cases the graduated rate using itemized deductions may result to lower tax due when it claims more expense than the illustration. Another point to take is that while you may claim many expenses, you must be vigilant that these expenses are properly substantiated and in accordance with related BIR regulations for it to be a valid expense or else these expenses may be disallowed for income tax purposes. Now, this is when the graduated rates using the optional standard deductions kick in as the 40% of the gross income that is used for deduction is a safe ground.
Conclusively, the illustration above is limited to only furthering the knowledge on the available tax schemes available. Understanding the tax schemes will allow the tax payers to file and pay the correct amount taxes due. Furthermore, due to the many factors at play, it is imperative that a tax payer must understand every advantages and disadvantages of each income tax schemes available. Eliminate stress and anxiety if you are still confused what tax scheme is perfect for you by doing research, attending seminars, and seeking help from professionals.
This article is for general information only and does not constitute professional advice. Therefore, the reader holds Morfe, Ceneta & Co., CPAs, including its partners, officers and employees free and harmless from any liability arising from one’s reliance on this article.