Western Mindanao State University

College of Liberal Arts

Accountancy Department

Income Taxation of Individuals

Conceptually, an individual may earn her income through any of the following means:
(1) Compensation Income –Compensation income arises from an employer-employee relationship, whether in the private or
public sector. The following are the elements of such relationship:
a. Selection and engagement of employees – There is a screening process for hiring.
b. Payment of wages – The employer usually fixes and controls the payment of wages.
c. Power of dismissal – The employer has the power to retrench or terminate employees when incurring heavy
losses or for other reasonable basis.
d. Powerofcontrol–Theemployerhasthepowertocontroltheemployeesonthemeansand methods by
which the work is accomplished.
As a general rule, compensation income is subject to income taxation through the withholding tax system, whereby the
employer collects in advance the income tax due of the employee on the compensation earned.
(2) Trade or BusinessIncome
(3) Incidental Income – For purposes of RIT, these are non-operating items of income (such as passive income and gains on dealings
of properties) that are not otherwise subject to FIT or CGT.

A. Taxable Compensation Income

Gross compensation income P xx
Less: Non-taxable compensation income (xx)
Gross taxable compensation income P xx

1. Gross Compensation Income

a. Regular compensation – fixed remunerations receivable on a periodic basis (e.g. basic salary and fixed allowances such as
cost of living allowance)
b. Supplementary compensation – additional compensation payments that are either legally mandatory or performance-
based, but are not necessarily paid periodically.
 Holiday pay
 Overtime pay
 Night shift differentialpay
 Hazard pay
 Commissions
 Fees
 Honoraria
 Profit sharing bonuses
 Value of living quarters or meals (not for necessity or convenience of the employer)
c. Other taxable benefits –13thmonth pay and other benefits inexcessofP90,000 . Other benefits include:
 Christmas bonus of private employees
 Cash gifts, other than Christmas or anniversary gifts, of private employees
 Additional compensation allowance (ACA) of government personnel
 14th month pay, 15th month pay, and so on
 Excess de minimis benefits received by rank-and-file employees
 Benefits of small value not included in the de minimis list received by rank-and-file employees
Note:Forthelasttwobulletsabove,whentheamountsarereceivedbymanagerialemployees,such amounts are not
subject to RIT but to a final tax called the fringe benefit tax.

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2. Non-taxable Compensation Income
a. Employee mandatory contributions to GSIS, SSS, PhilHealth, HDMF (Pag-Ibig) and Union Dues
b. De minimis benefits
 Monetized unused vacation leave credits of private employees not exceeding 10 days during the taxable year
 Monetized unused vacation and sick leavecredits paid to government officials and employees
 Medical cash allowance to dependents of employees not exceeding P1,500 per employee per semester
(6 mos.), or equivalent to P250 per month
 Rice subsidy of P2,000 per month or 1 sack of 50-kg rice per month valuing not more than P2,000
 Laundry allowance not exceeding P300 per month
 Uniform and clothing allowance not exceeding P6,000 per annum
 Actualmedical assistancenotexceeding P10,000perannum, e.g. medicalallowance tocover medical and
healthcare needs, annual medical/executive check-up, maternity assistance and routine medical consultations
 Employeeachievement award, which mustbe in the form of tangibleproperty other than cash or gift
certificates,receivedunderanestablishedwrittenplanwhichdoesnotdiscriminateinfavorof highly paid
employees and with an annual monetary value not exceeding P10,000 (e.g. for length of service award or safety
achievement)
 GiftsgivenduringChristmasandmajoranniversarycelebrationsnotexceedingP5,000perannum
 Benefits received under a collective bargaining agreement (CBA) and/or productivity incentive programs
with a combined annual monetary value not exceeding P10,000 per annum (new de minimis)
 Daily meal allowance for overtime and night or graveyard shift not exceeding 25% of the basic minimum
wage on a per region basis.
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c. 13 month pay and other benefits not exceeding P90,000
d. Benefits required by the nature of, or necessary to the trade, business or conduct of profession of the employer
(necessity of the employer rule) – Ex. Necessary traveling, transportation, representation or entertainment
expenses that are subject to accounting or liquidation.
e. Benefits for the convenience or advantage of the employer (convenience of the employer rule) – Ex.
 Car incentives to doctors on-call who are required to report for duty anytime
 Scholarship grant to employees under contract to remain in service for a specified period upon completion
of the study
 Housing privilege of military officials located inside or near the military camps

Illustration 1.
Arrabon is a private rank-and-file employee who received the following remunerations during the taxable year:
Salaries,grossofP24,000 SSS,PhilHealthand Pag-Ibig P254,000
Holiday pay 10,000
Traveling allowance (subject to liquidation) 15,000
13th month and other benefits 95,000

Answer: 245,000

Illustration 2.
Aubrey is a private employee receiving a P700 daily rate. He received the following benefits during the year:
Basic salary P250,000
Monetized unused vacation leave credits 8 days
Monetized unused sick leave credits 8 days
Rice subsidy 24,000
Laundry allowance 5,000
Medical allowance to dependents 5,000
Productivity incentive bonus 20,000
13th month pay 20,000
14th month pay 20,000
Overtime pay 15,000

Answer: 265,000

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 B. Types of CompensationEarners
1. Minimum Wage Earners (MWE) –refer to workers in the private sector who are paid the statutory minimum wageor to
employees in thepublic sector with compensation income of not more than the statutory minimum wagein thenon-
agricultural sector where they are assigned. The statutory minimum wage refers to the rate fixed by the Regional Tripartite
Wage and Productivity Board (RTWPB) under the supervision of the Department of Labor and Employment, or P5,000 per
month, whichever is higher.
*Taxability – MWEs are generally exempt from income taxation and hence exempt from the withholding tax on
compensation. To be considered as exempt MWE, however, the employee must:
 Not have other regular compensation other than her basic salary, which is the minimum wage
 Not have other supplementary compensation other than Holiday Pay, Overtime Pay, Night Shift Differential
Pay and Hazard Pay (HONZ)
 Not have other taxable benefits exceeding P90,000
 Not have other sources of income outside employment that are otherwise subject to regular income tax. If those
items of income are only subject to FIT or CGT, she is still an MWE.
Note: If any of the first 3 conditions above is not met, the MWE is already deemed taxable as a regular employee and hence
her entire income including the HONZ will be subject to the withholding tax on compensation. Ifthe4thconditionisnotmet,
theMWE maystillbeexempt from thewithholdingtax but will nonetheless file her own income tax return.

Illustration 1.
Joanais a minimum wage earner with the following information for the year from her employer:
Basic pay P90,000
13th month pay 7,500
Overtime pay 10,000
Hazard pay 5,000
Total compensation received P112,500

Answer: exempted because of bullet 2

Illustration 2.
Sarah is aminimum wage earner with the following information for theyear from her employer:
Basic pay P90,000
Fixed allowance (not subject to liquidation) 5,000
13th month pay 7,500
Holiday pay 5,000
Night shift differential pay 5,000
Total compensation received P112,500
Answer: 90+5+5+5=105

Illustration 3.
Mae Ann is a minimum wage earner with the following information for the year:
Basic pay P90,000
13th month pay 7,500
Interestfrom depositsin localbank 10,000
Dividends from domestic stocks 5,000
Total income received P112,500
Answer: exempt refer to bullet 4

2. Regular Employees –refer to employees that are not otherwise earning the statutory minimum wage and hence subject to
regular income tax.
*Taxability – All regular employees, whether citizens or aliens, are subject to the withholding tax system on compensation.
 If the employee is only earning compensation income from one employer (pure compensation earner), the
withheld tax, when correctly determined, is deemed the full and final payment of the incometax.Such
employee,therefore,isnolongerrequiredtofileherownincometaxreturnandis qualified for substituted filing,
where her employer files the income tax return on her behalf. Otherwise, if the tax was incorrectly
withheld, the employee will need to file her own income tax return.
 If the employee is earning compensation income from more than one employer (also a pure compensation
earner) or is earning other income subject to regular income taxation (mixed income earner), she will still be
subject to the withholding tax on her compensation. However, this will not bedeemed as full and final payment
of her income tax. Such employee will need to filean annual consolidated return for all her taxable items of
income and claim the withheld tax on her compensation as tax credit.

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 Note: Inthiscase,thecompensationincome will bereportedgrossofthewithheldtax.Thisisa logical implication
of the creditable withholding tax system.

C. Special Issues on Individual Taxation

1. Optional Standard Deduction –When theindividual taxpayer (except anNRA) isearning income fromthe conduct of trade,
business or profession, she can choose to report her actual deductible expenses (also called itemized deductions) or claim a fixed
rate of her revenues as deductible items (also called the OSD). The option to elect OSD or itemized deductions must be made in
the first quarter return. When no election is signified in such return, the choice of itemized deductions is presumed. The
election of the OSD, however, is only irrevocable for one taxable year. For individuals, the OSD is applied at 40% of the gross
sales or receipts, as applicable. Gross sales, in taxation, is the concept of net sales in accounting. Hence, sales returns, allowances
anddiscountsaretobedeductedfirst.Incontrast,OSDforcorporatetaxpayersis40%ofgrossincome.The following
summarizes all of the comparative points:

Individual Corporate
OSD OSD
In lieu of cost of sales/services? Yes No
In lieu of regular allowable deductions? Yes Yes
In lieu of special allowable deductions? Yes Yes
In lieu of NOLCO? Yes Yes
In lieu of capital loss? Yes Yes
In lieu of Personal Exemptions? No N/A
Applied to other income? No Yes

Illustration 1.
Christeen, single, is a sole proprietor of a retail shop. The following relates to her business for the year:

Gross sales (per accounting) P4,000,000

Sales returns and allowances 200,000
Cost of sales 2,500,000
Rent income (net of P15,000 WT) 285,000
Interest income from bank deposits 20,000
Interest income from customers’ notes 50,000
Operating expenses 1,200,000

1. Compute Christeen’s income tax still due if she opts for itemized deduction.
Answer: 27,500

2. Compute Christeen’s income tax still due if she opts for OSD.
Answer: 676,600

2. Quarterly Payments of Income Tax – As previously mentioned, individuals earning business income, whether with or without other
forms of income, must file quarterly returns in addition to their annual income returns. There are three major points to
remember for quarterly returns of individuals:
 Personalexemptionsarenotappliedonquarterlyreturns.Theyareonlyappliedonannualreturns.
 The net taxable income for each quarter is determined on a cumulative basis, i.e. the net taxable income from the previous
quarter/s is added to the current quarter’s net taxable income.
 The income tax payments of the previous quarter/s are allowed as tax credits for the current quarter’s income tax liability.

Illustration.
Jhoniel, single and resident citizen of the Philippines, is the owner of a business called Jugs To Go. The following are his taxable income
for each quarter of the year:
First quarter P400,000
Second quarter 400,000
Third quarter ( 50,000)
Fourth quarter 230,000

Required: Determine Jhoniel’ income tax payable for his periodic returns.

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 1. Foreign Tax Credit –Taxpayers with a worldwide situsoftaxation, such as resident citizens and domestic corporations, are
allowed anoptional treatment ofdiminution forthetaxesthey pay inforeigncountrieson the same items of income that are also
subject to regular income tax in the Philippines. Such taxpayers may report theforeigntaxespaid asregularitemizeddeductions
orclaimthemastaxcredits.Whenclaimedastaxcredit, the allowable credit amount is the lower between the actual
foreign tax paid and the following limit:
Foreignnetincome Income Tax Due
World net income

Illustration 1. One Foreign Country

A resident citizen, single, reported the following data for the year:

Business income – Philippines P4,000,000

Business income – Colombia 3,500,000
Business expenses – Philippines 2,200,000
Business expenses – Colombia 2,300,000
Quarterly taxes paid – Philippines 200,000
Income tax paid – Colombia 300,000

Illustration 2. More than One Foreign Country

A resident citizen, with 2 qualified dependents, has the following data for the year:

Net operating income – Philippines P1,800,000

Net operating income – Germany 1,000,000
Net operating income – Australia 1,200,000
Income tax paid – Germany 200,000
Income tax paid – Australia 400,000

D. Taxpayers Deemed Individuals (Estates and Trusts)

 Estate – refers to all the property, rights and obligations of a deceased person which are not extinguished by her death. To be
taxable on its income, the estate must be under judicial settlement.
 Trust–a fiduciaryrelationship inwhichoneparty, known asatrustor, givesanother party, thetrustee, the right to hold title
to the property or assets for the benefit of a third party, the beneficiary. To be taxable on its income, the trust must be
irrevocable as to both its principal and income.

General Rules:
a. Being deemed individuals, the income of the estate or trust is taxed using the same progressive tax rates.
b. Theincomedistributed ordistributable to the beneficiaries outofthe estate or trustis allowedasa special
deduction.
c. In case of two or more trusts, where the trustor for each is the same person and the beneficiary for each is the same
person, the annual taxable income of all the trusts shall be consolidated and hence, can only claimone basic
personalexemption. Theincometax still duefor theconsolidated return shall be apportioned to each trust using
their respective ratio of net taxable income.

Illustration 1. Income of an Estate

Cardo died, leaving an estate valued at P3,000,000. Such properties are still under judicial settlement. During the year, the estate
earned P600,000 gross income before business expenses of P250,000. Out of this income, however, P150,000 was distributed
to the rightful heirs during the year.

Illustration 2. Income of Multiple Trusts

Marivie designated three trusts, all in favor of Shehan. The following are the details:

Gross Allowable
Trust Designation Income Expenses
1 Irrevocable P200,000 P20,000
2 Revocable 300,000 30,000
3 Irrevocable 400,000 40,000

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