CHAPTER 13-B (WEEK 9)

SPECIAL ALLOWABLE ITEMIZED DEDUCTIONS & NET OPERATING LOSS CARRY-

OVER (NOLCO)
Chapter Overview and objectives:

This chapter covers special itemized deductions and the net operating loss carry over.

After this chapter, readers are expected to demonstrate of the following:

1. Special deduction allowed under the NIRC and special laws

2. Requisites and deduction rules of the allowable special expenses
3. Additional deduction incentives granted by special laws
4. Measurable and carry-over rules of Net Operating Loss Carry-Over (NOLCO)

Special Allowable Deductions

Special deductions are other items of deductions which may or may not partake the nature of
an expense, but are allowed by the NIRC or by special laws as deductions. Special deductions
include deduction incentives to taxpayers in assisting and in complying with certain legal
requirements.

Special Allowable Deductions

A. Special expenses under the NIRC and special laws
1. Income distribution from a taxable estate or trust
2. Transfer to reserve fund and payment to policies and annuity contracts of insurance
companies
3. Dividend distribution of a Real Estate Investment Trust (REIT) under RA 9856
4. Transfer to reserves funds of taxable cooperatives
5. Discount to senior citizens under RA 9257
6. Discount to persons with disability under RA 9443

B. Deduction incentives under special laws

1. Additional compensation expense for senior citizens employees under RA 9257
2. Additional compensation expense for persons with disability under RA 7277, as amended by
RA 9442
3. Cost of facilities improvements for persons with disability in accordance with RA 7277, as
amended by RA 9442
4. Additional training expense under the RA 8502 – Jewelry Industry Development Act of 1998
5. Additional contribution expenses under the Adopt-a-School program under RA 8525
6. Additional deductions for compliance to rooming-in and breast- feeding practices under RA
7600, as amended by RA 10028
7. Additional free legal assistance expense under RA 9999
8. Additional productivity incentive bonus expense under RA 6971

SPECIAL EXPENSES UNDER THE NIRC OR SPECIAL LAWS

INCOME DISTRIBUTION MADE BY TAXABLE ESTATES OR TRUSTS

Income distribution made by the administrator of a taxable estate in favor of the heirs or by a
trustee of a taxable trust in favor of the beneficiary of the trust is a special deduction against
the gross income of the estate or trust. The income distribution shall be included by the
recipient heir or beneficiary in his gross income.

Illustration
Don Mariano transferred a commercial lot and a P1M stock investment in irrevocable trust in
favor of his son, Ritchie. The trust earned the following income in 2014:

Rent income on the lot P 1,200,000

Less: leasing expenses 200,000
Rental net income P 1,000,000
Dividend income, net of final tax 36,000
Trust net income P 1,036,000

In accordance with the trust indenture, the trustee distributed half of the gross rentals and the
entire dividends to Ritchie

Special deduction
The special deduction is P600,000, the half of the gross rentals given to Ritchie. The
distribution of the P36,000 dividend to Ritchie shall not be deductible as this is not included in
the gross income of the trust for purposes of the regular income tax.

The net income of the trust shall be computed as follows:

Gross rent income P 1,200,000

Less:
Regular allowable deductions P 200,000
Special allowable deductions
Income distribution to beneficiary 600,000 800,000
Net income P 400,000
NET TRANSFER TO RESERVED FUND AND PAYMENTS TO POLICIES AND ANNUNITY
CONTRACTS OF INSURANCE COMPANIES
Under the Insurance Code, non- life insurance companies are required to maintain a reserve
equivalent to 40% of their gross premium, less returns and cancellations for risks expiring
within one year. For marine cargo risks, the reserve is equivalent to the amount of premium on
insurance during the last two months of the calendar year.

The net additions, if any, required by law to be made within the year to the reserve funds and
the sums, other than dividends, paid within the year on policy and annuity contracts may be
deducted from the gross income of insurance companies.

Under current regulations, the transfer to the reserve fund shall be deductible in the year it
was actually paid and not in the year it was determined. Also in consonance with the tax
benefit rule, the release of the reserve is treated as an income in the year of release.

Illustration
The following relates to the performance of an insurance company:

2012 2013 2014

Premium revenue P 2,100,000 P 3,000,000 P 2,500,000
Premiums ceded 420,000 600,000 500,000
Claims expense 200,000 800,000 1,000,000
Commission expense 100,000 300,000 250,000
Administrative expenses 300,000 350,000 340,000
Requires legal reserves 672,000 960,000 800,000

Required: Determine the special deductions and the net income assuming that the required
transfers to the reserve funds were made in the same year.

Solution:
The net which will be paid to or released from the reserve fund is computed as follows:

2012 2013 2014

Required reserves P 672,000 P 960,000 P 800,000
Less: prior year-reserve 0 672,000 960,000
Amount payable (receivable) P 672,000 P 288,000 (P 160,000)

To simplify our illustration, let us assume that the contributions to the reserve were paid in the
same year they were determined.
The net income of the insurance company shall be computed as follow:

2012 2013 2014

Premium revenue P 2,100,000 P 3,000,000 P 2,500,000
Less : premium ceded 420,000 600,000 500,000
Net premium P 1,680,000 P 2,400,000 P 2,000,000
Release from reserve - - *160,000
Gross income P 1,680,000 P 2,400,000 P 2,160,000
Less:
Regular allowable deductions
Claims expense P 200,000 P 800,000 P 1,000,000
Commission expense 100,000 300,000 250,000
Administrative expense 300,000 350,000 340,000
Total P 600,000 P 1,450,000 P 1,590,000
Special allowable deduction
Payment to reserve 672,000 288,000 -
Total deductions P 1,272,000 P 1,738,000 P 1,590,000
Net income P 408,000 P 662,000 P 570,000

Note: The release of reserve from the reserve fund is included in gross income

DIVIDEND DISTRIBUTION OF A REAL ESTATE INVESTMENT TRUST (REIT)

A REIT is a publicly listed corporation established principally for the purpose of owning income-
generating real estate assets. A REIT is legally mandated to distribute 90% of its distributable
income as dividends to shareholders

Under RA 9856, the dividend distributions of REITs are treated as special deductions against
gross income.

For purposes of computing the taxable net income of REITs, dividends distributed by them
from their distributed income after the close of a taxable year and on or before the last day of
the fifth month following the close of the taxable year shall be considered as paid on the last
day of such taxable year.

TRANSFER TO RESERVE FUND OF COOPERATIVES

Under RA 9520, cooperatives are required to maintain reserves for their protection and
stability. Cooperatives are exempt from income tax, but are subject to tax on their income
from unrelated activities. The amount transferred by the cooperative to the reserve fund our
of the net surplus from unrelated activities is an item of deduction in the computation of the
taxable net income of the cooperative.

Illustration:

Lowland Coop summarized the following income and expenses from this exempt related
activities and taxable unrelated activities:

Related Unrelated
Activities Activities Total

Sales P 2,000,000 P 1,000,000 P 3,000,000

Cost of sales 1,200,000 600,000 1,800,000
Gross income P 800,000 P 400,000 P 1,200,000
Operating expenses 500,000 150,000 650,000
Net income P 300,000 P 250,000 P 550,000

In compliance with the cooperative Development Act, Lowland Coop appropriates 10% of
profit to the reserve fund, plus additional 40% to other required and optional funds.

T he amount of special deduction and the taxable net income of the cooperative shall be
computed as:

Gross sales from unrelated activities P 1,000,000

Cost of sales 600,000
Gross income from unrelated activities P 400,000
Less: Regular itemized deductions 150,000
Net income before statutory reserves P 250,000
Less: Special itemized deduction
Appropriation to reserve fund (P250K X 10%) 25,000
Taxable net income P 225,000

Note: Only the appropriation for the reserve fund is deductible as a special expense. The 4%
appropriations for other cooperative funds are not deductible.

THE EXPANDED SENIOR CITIZEN’S ACT OF 2003 (RA 9257)

Senior Citizen or Elderly

Senior citizens or elderly refers to any resident Filipino citizens aged 60 years old and above.

Under RA 9257, a senior citizens or elderly is entitled to 20% discount in certain establishments
such as hotels and similar lodging establishments, restaurants, recreational centers and other
places of culture, leisure and amusements, hospital, drugstores, and services such as medical,
dental, domestic air, sea and land transport, and funeral or burial service providers.

The discount granted to senior citizens by covered establishments and services providers are
allowed as special deductions against gross income.

Conditions for deductibility of sales discount to senior citizens

1. Only that portion of the gross sales exclusively used, consumed, or enjoyed by the senior
citizens shall be eligible for the deductible sales discount.
2. The gross selling price and the sales discount must be separately indicated in the official
receipt or sales invoice issued by the establishment for the sale of goods or services to the
senior citizens. 3. Only the
actual amount of the discount granted or sales discount not exceeding 20% of the gross selling
price can be deducted from gross income, net of VAT, if applicable.
4. The discount can only be allowed as deduction from gross income for the same taxable year
that the discount is granted.
5. The business establishment giving sales discount to qualified senior citizens is required to
keep a separate and accurate record of sales which shall include the name, TIN, ID, gross
sales/receipts, discount granted, date of transaction, and invoice number for every sale
transaction to senior citizens.

Illustration 1
Goodhealth Drugstore Inc. recorded a P 1,200,000 total deductive expense and the following
sales:

Customer
Regular Senior citizens
Gross sales P 5,000,000 P 1,200,000
Cost of sales 3,000,000 800,000

Goodhealth adopts a policy of giving senior citizens a 25% discount. Consequently, it granted
P300,000 total senior citizens’ discount during the period.

The taxable net income of Goodhealth shall be computed as:

Gross sales (P5M + P1.2M) P 6,200,000

Cost of sales (P3M + P0.8M) 3,800,000
Gross income from operations P 2,400,000
Less:
Regular itemized deductions P 1,200,000
Special itemized deductions
Senior citizens’ discount
(P1.2M x 20%) 240,000 1,440,000
Taxable net income P 960,000

Note:
1. The gross sales to senior citizens must be reported gross of the senior citizens’ discount
while the discount is presented as a separate expense.
2. The claimable senior citizens discount shall not exceed 20% of the gross sales from senior
citizens. Hence, the deductible amount is P240, 000 not P300,000.

Illustration 2
Tasty Restaurant Corporation provides a 20% discount to senior citizens. It recorders the
following receipts during the year:
Customers

Regular Senior Citizens Total

Receipts P 4,000,000 P 500,000 P 4,500,000
Cost of service 2,800,000
Other deductible expenses 1,100,000

The specials deduction for senior citizens’ discount and the net income of Tasty Restaurant
shall be computed as:

Gross receipts (P4M+ (P500K/80%) P 4,625,000

Less: Cost of service 2,800,00
Regular itemized deductions P 1,100,000
Special itemized deductions
Senior citizens’ discount
(P500K/80%) x 20% 125,000 1,225,000
Taxable net income P 600,000

Note:
1. Receipts pertain to cash collections which are inherently net of any discount provided.
Hence, the receipts from senior citizens must be grossed-up.
2. The discounts must not be deducted out of net receipts.

DISCOUNTS TO DISABLED PERSON (RA 7277)

A person with disability pertains to an individual suffering from restriction or different abilities
as a result of mental, physical, or sensory impairment or performs an activity in a manner or
within the range considered normal for human beings.
Disability pertains to physical or mental impairment that substantially limits one or more
psychological, physiological, or anatomical functions of an individual or activities of such
individuals.

Discount to persons with disability

Similar to senior citizens, person with disability are entitled to a 20% discount from certain
establishment such as hotels and similar lodging establishment, restaurants, sports and
recreation centers, places of culture, leisure and amusement, drugstore on the purchase of
medicine, medical and dental services in private facilities, and domestic air, sea, and land
transport.

The discounts to persons with disability shall be allowed as special deductions under the same
terms and conditions as those for senior citizens.

DEDUCTIONS INCENTIVES UNDER SPECIAL LAWS

ADDITIONAL CLAIMABLE COMPENSATION EXPENSE FOR SENIOR CITIZENS EMPLOYESSS

Under RA 9257, private establishment employing senior citizens shall be entitled to additional
deductions from gross income equivalent to 15 % to the amount paid as salaries and wages to
senior citizens.

Conditions for deductibility of additional compensation:

1. Employment shall have to continue for at least 6 months
2. The annual amount taxable income of the senior citizens does not exceed the poverty level
as determined by the NEDA

The poverty line or poverty threshold pertains to the amount of income sufficient to meet
basic food and non-food needs such as clothing, housing, transportation, and health among
others. The senior citizens shall submit to his employer as sworn certification that his annual
taxable income does not exceed the poverty level.

Illustration
Assume a taxpayer employs both regular and senior citizens employees and paid the following
compensation during the year:

Regular employees P 200,000

Senior citizens employees with salary grades
above poverty level 50,000
Senior citizens employees with salary grades
below poverty level 40,000
Total compensation expense P 290,000
The total deductible compensation expense shall be:

Regular employees P 200,000

Senior citizens employees 90,000
Regular salaries expense P 290,000

Additional compensation expense

under RA9 9257 (P40, 000 x 15%) P 6,000

The 15% additional deduction is definitely not an actual expense, but is allowed by law merely
as an incentive for employers who consider senior citizens for employment. The regular
salaries will be presented as part of regular allowable itemized deductions. The 15$ additional
deduction shall be presents as special allowable itemized deduction.

Senior citizens who are above the poverty level may avail of incentives under the Minimum
Wage law if they qualify as minimum wage earners.

ADDITIONAL CLAIMABLE COMPENSATION EXPENSE FOR PERSONS WITH DISABILITY

Private entities that employ disabled persons who meet the required skills or qualification,
either as regular employees, apprentices or learners, shall be entitled to an additional
deduction, from their gross income, equivalent to twenty-five percent (25%) of the total
amount paid salaries and wages to disabled persons:

Requisites for deductibility:

a. The entity present proof as certified by the Department of Labor and Employment that
disabled persons are under their employ
b. The disabled employee is accredited with the Department of Labor and Employment and
the Department of Health as to his disability, skills, and qualifications.

The actual salaries shall be presents as part of regular expense while the 25% additional
salaries expense shall be presented as special itemized allowable deductions.

COST OF FACILITIES IMPROVEMENT FOR DISABLED PERSONS

Under RA 7277, private entities that improve or modify their physical facilities in order to
provide reasonable accommodation for disabled persons shall also be entitled to an additional
deduction from their income equivalent to fifty percent (50%) of the direct costs of the
improvements or modifications.
ADDITIONAL TRAINING EXPENSE UNDER THE JEWELRY INDUSTRY DEVELOPMENT ACT OF
1998

Under RA 8502 and its implementing rules and regulations, a qualified jewelry enterprise duly
registered and accredited with the Board of Investment (BOI) is entitled to additional
deductions from taxable income of 50% of the expense incurred in training schemes approved
by technical Education and Skills Development Authority (TESDA). The same shall be
deductible during the year the expenses were incurred.

Conditions for deductibility:

1. A qualified jewelry enterprise must submit to the BIR a certified true copy of its Certificate
of Accreditation issued by the BOI.
2. The training scheme must be approved and certified by TESDA.

ADOPT-A-SCHOOL ACT OF 1998 (RA 8525)

Under the Adopt-a-School Program, private entities are allowed to assist a public school in
particular aspects of their educational program within an agreed period of time.

The adopting private entity which may be an individual in business or practice of profession, a
partnership, or a corporation shall team up with the DepED, CHED, or TESDA toward providing
much needed assistance and service to public schools.

The assistance may be an aid, contribution or donation in cash or in kind but not limited to
infrastructure, physical facilities, real estate property , training and skills development,
learning, support, reading materials, computer and science laboratories, health and nutrition
packages, and assistive learning devices for student with special needs.

Qualification of participating schools

Any government school in all levels may participate in the program. Priorities shall be given to
schools located in the poorest provinces, low income municipalities, and other local
government units experiencing severe classroom shortages, insufficient budget, or having
numerous poor but high performing learners.

Qualifications of Adopting Private Entity

1. It must have a credible track record.

2. It must have been in existence for at least one year
3. It must not have been prosecuted and found guilty of engaging in illegal activities such as
money laundering and other similar circumstances.
Tax deduction incentive
Contributions to the government in priority activities are deductible in full while those made in
non-priority activities are deductible subject to limit.

Aside from the usual regular deductible contribution expense, an adopting entity shall be
allowed an additional deduction from gross income equivalent to 50% of the contribution of
the adopting entity for the “Adopt-A-School Program.”

Conditions for deductibility:

a. The deduction shall be availed of in the taxable year in which the expense is paid or
incurred.
b. The expense is substantiated with sufficient evidence such as official receipts, delivery
receipts and other adequate records which shall set forth the following:
a. The amount of expenses being claimed as deductions
b. Direct connection or relation of the expenses to the adopting private entity’s
participation in the Adopt-a-School Program.
c. Proof or acknowledgement of receipt of the contributed or donated property by the
recipient public school.
c. The application together with the approved MOA endorsed by the National Secretariat shall
be filed with the RBO having jurisdiction over the place of business of the adopting private
entity, copy furnished the RBO having jurisdiction over the property, if the contribution is in
the form of real property.

Procedures for availment

1. Memorandum of Agreement
An adopting private entity shall be into a Memorandum of Agreement (MOA) with the head of
the public school. The minimum of 2 years pre-terminable only when the adopting private
entity is dissolved prior to the end of such period or when terminated for failure to possess the
qualification as such.

2. Supporting evidence
The adopting entity must maintain sufficient evidence of the amount of assistance incurred,
establish the connection of the expense to the adopting entity’s participation in the program,
and maintain proof of acknowledgement of receipt by the public school recipient of the
donation.

3. Apply for Certificate of Tax Incentives and Tax Exemption

The adopting entity shall apply for a Certificate of Tax Incentive or Tax Exemption sand submit
the following documents to the Secretariat:
 a. Duly authorized or approved MOA
b. Duly notarized deed of donation
c. Official receipts and other documents showing the actual value of the contribution or
donation.
d. Certificate of Title and Tax Declaration, if the donation is in the form of property
e. Other adequate records showing direct connection or correlation of the expense
being claimed as deduction to the adopting entity’s participation in the program.

Illustration
In 2016, Robotics Inc. entered into a memorandum of agreement with two schools to adopt
them as part of its corporate social responsibility:

Name Nature Assistance granted

Balakbak High School A public secondary P 1,500,000
school
Divine World College A non-profit accredited P 1,000,000
done institution

An adopt-A-Child program was designated by the NEDA as a priority program in the 2016
National Priority Plan.

Robotics Inc. shall claim the following contributions expense as part of regular itemized
allowable deductions:

Contribution to accredited done NGO P 1,000,000

Contribution expense under RA 8525 1,500,000
Regular deductible contribution expense P 2,500,000

Robotics Inc shall likewise claim the following additional contribution expense as special
itemized allowable deductions:

Contribution expense under RA 8525 P 1,500,000

Multiply by: 50%
Special additional contribution expense P 750,000

Note: Only donations to public schools are allowed the additional deduction.

Valuation of deductions (RR10-2003)

1. Cash assistance, contributions or donations shall be based on the actual amount appearing
in the official receipt issued by the done.
2. Assistance other than money
 a. Personal property - acquisition cost of assistance or contribution
b. Consumable goods – acquisition cost or value at date of donation whichever is lower
c. Service – the value of services rendered by the donor and the service provider and the
public school as fixed in the MOA or the actual expense incurred by the donor,
whichever is lower
d. Real property – fair value (higher of zonal value or assessed value) at the time of
contribution or the depreciated cost of the property whichever is lower

Illustration 1
In 2016, Banawe Realty Corporation participated in the “Adopt-a-School Program” by
contributing its service to a public school in La Trinidad, Benguet. The agreed value fixed in the
MOA for the construction of the public school building was P1,000,000. However, Banawe
Realty was able to complete the same at a total cost of P800,000.

The “Adopt-a-School” is a priority program in 2015. Banawe Realty Corporation shall be

allowed to deduct the following:

Regular itemized contribution expense P 800,000

Special itemized contribution expense (P800K x 50%) P 400,000

Note: The lower of the actual cost of services and the agreed value shall be considered.

Assume that the “Adopt-a-School Program” is no longer a priority program in 2015, and
Banawe Realty has P9,000,000 net incomes before the contribution. Banawe Realty shall be
allowed to deduct the following:
Contribution expense subject to limit P 800,000
Contribution limit: 5% x P9,000,000 450,000
Regular itemized contribution expense P 450,000
Special itemized contribution expense (P800K x 50%) 400,000

Note:
1. For corporations, contributions to the government in non-priority activities are subject to a
limit of 5% of the net income before the contribution.
2. The basis of the additional incentive is the actual donation as valued under RR10-2003, not
the amount of the regular allowable itemized contribution expense.
Illustration 2
Victory Bus Line contributed a lot and a bus to its adopted public school. The lot shall be used
by the public school for building expansion and the bus as a school bus. The “Adopt-a-School
Program” is a national priority program during the year.
The following relates to the lot and the bus:
Appraisal value of lot P 5,000,000
Zonal value of the lot 3,600,000
Assessed value of the lot 2,500,000
Acquisition cost of the lot 3,000,000
Acquisition cost of the bus 2,400,000
Depreciated cost of the bus 1,500,000
Depreciated appraised cost of bus 2,000,000
The contribution expense deductible as part of regular itemized allowable deductions shall be
computed as follows:
Contribution
Expense

Zonal value P 3,600,000

Assessed value 2,500,000
Fair value of the (higher) P 3,600,000
Cost of the lot (LOWER) P 3,000,000 P 3,000,000
Depreciated cost of bus 1,500,000
Regular itemized contribution expense P 4,500,000

The contribution expense deductible as part of special itemized allowable deductions shall be
computed as follows:

Total value of donation P 4,500,000

Multiply by: 50%
Special additional contribution expense P 2,250,000

The P150,000 cost of compliance shall be claimed as part of regular itemized deductions. An
additional expense for the same amount shall be claimed under special itemized allowable
deductions.

Illustration 2
Baguio Medical Center (BMC), a private hospital, previously set up a milk storage facility and a
milk bank. The total annual costs of the two facilities were:

Storage Milk
Facility Bank Total
Supplies P 100,000 P 120,000 P 220,000
Staff salaries 210,000 90,000 300,000
Maintenance 50,000 70,000 120,000
Total P 360,000 P 280,000 P 640,000
Less: Fees collected from patients 190,000
Excess expense P 90,000

The milk bank was operated as an integral part of the hospital, but is operated as non-profit.
BMC charges minor fees and subsidizes the facility excess expense.

BCM may claim the following expense as part of regular –itemized allowable deductions:

Total operating costs of storage facility P 360,000

Excess Milk bank expense subsidized by BMC 90,000
Total P 450,000

BMC shall also claim an additional deduction for the same amount as special itemized
allowable deductions.

Illustration 3
Tabuk Provincial hospital, a state hospital, set up a milk storage facility at total costs of
P1,120,000.

Required: Determine the allowable special deduction.

Answer:
Nil. Tabuk Provincial Hospital cannot claim deductions since it is non-taxable. However,
government facilities, establishment, and institutions will receive additional appropriation
equivalent to the savings they made derive as a result of complying with Ra 10028.

These savings may come from reduced costs due to absenteeism, increased productivity,
reduced illness of babies, and reduced cost of procurement, sterilization, and management of
infant formula paraphernalia.

FREE LEGAL ASSISTANCE (RA 9999)

Lawyers or professional partnership providing pro-bono legal services are given deduction
incentives for their free legal services.

Requirements for availment

Lawyers or professional partnership rendering actual free legal services shall secure a
certification from the Public Attorney’s Office (PAO), the Department of Justice (DOJ), or
association accredited by the Supreme Court indicating that the said legal services to be
provided are within the services defined by the Supreme Court and that the agencies cannot
provide the legal services to be provided by the legal counsel.
The association and/or organization duly accredited by the Supreme Court shall issue then
necessary certification for the number of hours actually provided by the lawyer or partnership.

Tax Deduction Incentive

The practicing lawyer or professional partnership shall be entitled to an allowable deduction
from gross income equivalent to the amount that could have been collected for the actual
performance of the actual free services rendered or up to 10% of gross income derived from
the actual performance of the legal profession whichever is lower.

For the purpose of this incentive, the free legal services must be exclusive of the 60-hour
mandatory free legal assistance rendered to indigent clients as mandatorily required under the
Rule on Mandatory Legal Aid Services for Practicing Lawyers.

Illustration 1
A general professional partnership of lawyers had the following data during the year.

Gross receipts P 4,000,000

Interest on client notes 200,000
Interest on deposits 36,000
Value of pro-bono services, exclusive of indigent clients 240,000
Direct cost of service 1,700,000
Administrative costs 1,200,000

The special deduction for free legal services shall be determined as follows:

Gross receipts P 4,000,000

Direct cost of service 1,700,000
Gross income from operations P 2,300,000
Multiply by: 10%
Deduction limit P 230,000
Actual free services provided P 240,000
Special “free legal service expense” (LOWER) P 230,000

Note: The interest income on notes is an item of gross income subject to regular income tax,
but is excluded as it is not derived from the actual performance of the legal profession.

The net income of the general professional partnership shall be computed as follows:
Gross receipts P 4,000,000
Direct cost of services 1,700,000
Gross income from operations P 2,300,000
Other gross income 200,000
Total gross income P 2,500,000
Less:
Regular itemized deductions P 1,200,000
Special itemized deductions
Free legal service expense 230,000 1,430,000
Net income P 1,070,000

Illustration 2
Atty. Sabado rendered the following services during the year:

Gross receipts from legal fees P 5,000,000

Value of 60-hour assistance to indigent clients 200,000
Value of other pro-bono services 450,000
Direct cost of services 1,500,000
Other deductible expense 1,500,000
Atty. Sabado shall be entitled to an additional deduction computed as follows:

Actual value of pro-bono services P 450,000

Limit of incentives :
Gross receipts P 5,000,000
Direct cost of services 1,800,000
Gross income from operations P 3,200,000
Multiply by: limit rate 10%
Deduction limit P 320,000

Special free legal service expense (LOWER) P 320,000

The net income of Atty. Sabado shall be computed as follows:

Gross receipts from legal fees P 5,000,000

Less: Direct costs of services 1,800,000
Gross income P 3,200,000
Less:
Regular itemized allowable deductions P 1,500,000
Special itemized allowable deduction
Free legal services expense 320,000 1,820,000
Net income P 1,380,000
ADDITIONAL PRODUVTIVITY INCENTIVE BUNOS EXPENSE
Under the Productivity incentive Act of 1990 (Ra 6971), a business enterprise which adopts a
productivity incentive program is entitled to a special additional deduction equivalent to 50%
of the total productivity bonuses given to employees under the program.

In addition, business enterprise providing manpower training and special studies to rank-and-
file employees as accredited by the Technical Education and Skills Development Authority are
also entitled to 50% additional deductions of the total grant for local training and special
studies.

However, the deduction incentives will not be allowed on bonuses accruing during the
pendency of a strike or lockout arising from any violations of the productivity incentive
program.

Illustration
To improve productivity, Cogon Company negotiated with its factory employees a productivity
incentive program wherein the employees shall receive a productivity bonus equivalent to 40%
of production cost saving which shall be measured by an independent expert.

Cogon Company also required employees to undergo studies though an “employee

advancement study program” which the TESDA. All employees who finished their special
studies were required to remain at the employer’s business for a period not less than one
year.

The following were determined during the years:

Total distributable productivity bonus P 1,000,000

Cost of special studies
Supervisory employees P 300,000
Rank and file employees 1,700,000 2,000,000
Total P 1,350,000

Aside from deducting the above employee benefit expenses, the employer shall be entitled to
the following special deduction incentives:

Additional productivity bonus expense (P1M x 50%) P 500,000

Additional expense on employee studies (P1.7M x 50%) 800,000
Total productivity incentive expense P 1,350,000
Note:
1. The incentive on special studies covers rank and file employees only
2. The costs of the special studies will not be subject to regular tax or fringe benefit tax as they
are granted for the convenience of the employer.

Note to readers

The deduction incentives discussed in the following section are some of the more common
incentives to taxpayers. There are other deduction incentives granted by special laws to
various taxpayers across different industries. The list shown in this chapter is merely intended
as illustrative to show the practical application of deduction incentives in income taxation.

NET OPERATING LOSS CARRY-OVER

Net operating loss (NOL) pertains to the excess of allowable deductions over the gross income
from business or exercise of a profession during a taxable year.

Net operating loss carry-over (NOLCO) pertains to the amount of net operating loss that is
allowed by the laws to be carried over as deduction against available net income in the
following three years.

NOLCO is computed as follows:

Gross income subject to regular tax P xxx,xxx

Less:
Total deductions excluding NOLCO from prior years
and deduction incentives under special laws xxx,xxx
Net operating loss carry-over P xxx,xxx

It must be noted that deduction incentive under special laws are not actual costs; hence, they
are excluded in the amount of the net operating loss carry-over. Moreover, deduction
incentives are legally allowed only as deduction incentives are not warranted. The NOLCO of
prior years shall be excluded in the measurement of the NOLCO of the current year to avoid
breaching the three-year prescriptive period rule.

NOL vs. NOLCO

It must be noted that a net operating loss is technically different with a NOLCO. A net
operating loss may occur, but may not be carried over, hence, no NOLCO. However, a NOLCO
cannot exist without a prior year net operating loss.
The Rationale of NOLCO

NOLCO is intended to allow the taxpayer to recoup his losses before taxation go full swing.
Without NOLCO, income taxation would result in taxation of recoveries of lost capital.

Illustration:
Assume the following operating (losses) or profits of the taxpayer:

Year 1 Year 2 Year 3 Year 4

Operating loss (P 400,000) (P 300,000) (P 200,000) P 200,000
(profit)

There is no tax in Year 1 through Year 3 because there is a loss. However, to tax the very
minimal profit of Year 4 would be too discouraging for taxpayers to engage in business. Hence,
the law allows operating losses to be carried over as deductions subject to certain conditions.
This is essential to allow the taxpayer to recoup his losses before being fully taxed.

Who can claim NOLCO?

All taxpayers subject to tax on taxable income whether at the regular income tax or at
preferential tax rate can deduct NOLCO. Taxpayers who are exempt, enjoying a tax holiday,
subject to tax on gross income, or subject to final income tax, cannot deduct NOLCO.

Illustration: NOLCO Computation

Nexus Corporation incurred a net operating loss during the year.

Gross income P 1,500,000

Less:
Regular itemized deductions P 1,200,000
Special deduction under the NIRC 700,000
Deduction incentives under special laws 300,000 2,200,000
Net operating loss (P 700,000)

Treatment of NOLCO
Net operating loss carry-over (NOLCO) is treated as a separate item of deduction in the next
three (3) consecutive taxable years to the extent of the available net income in those periods.
Illustration
A corporate taxpayer reported the following net income and loss from business:

2012 2013 2014 2015

Gross income P 400,000 P 500,000 P 720,000 P 900,000
Less: Deductions 600,000 450,000 610,000 650,000
Net income (NOLCO) (P 200,000) P 50,000 P 110,000 P 250,000

Required: Compute the taxable net income from 2013 to 2015.

The 2013 taxable net income is likewise nil. The NOLCO application and the 2012 NOLCO
balance as of December 31, 2014 are as follows:

2012 2013 2014 2015

Net income (NOLCO) (P 200,000) P 50,000 P 110,000 P 250,000
NOLCO deduction 50,000 ( 50,000)
NOLCO balance (P 150,000) P 0
The 2014 taxable net income is likewise nil. The NOLCO application and the 2012 NOLCO
balance as of December 31, 2014 are as follow:
2012 2013 2014 2015
Net income (NOLCO) (P 150,000) P - P 110,000 P 250,000
NOLCO deductions 110,000 ( 110,000)
NOLCO balance ( 40,000) P 0

The 2015 taxable net income shall be P 210,000, computed as:

2012 2013 2014 2015
Net income (NOLCO) (P 40,000) P - P - P 250,000
NOLCO deduction 40,000 ( 40,000)
P - Adjusted net income P 210,00

Note: Any unused NOLCO after the three year prescriptive period will expire and will not be
creditable in future periods.

Requisites for the deductibility of NOLCO:

1. The taxpayer must not be exempt from income tax during the taxable year when the NOLCO
was incurred.
2. There has been no substantial change in the ownership of the business or enterprise.
A change of least 75% of either the paid up capital or nominal value of the outstanding shares
of a corporation is deemed a substantial change in business ownership.

Illustration: NOLCO from exempt years

In 2013, Mr. Tan started a “Hot Siopao” manufacturing plant with less than P3M capitalization
was registered as a Barangay Micro Business Enterprise (BMBE). At the start of 2014, Mr. Tan’s
certificate of authority to operate as BMBE was revoked when he upscale his business
operations.

Mr. Tan’s business gross income and business expense were as follows:
2013 2014 2015
Gross business income P 400,000 P 700,000 P 1,500,000
Less: Business expense 650,000 800,000 1,000,000
Net income (NOLCO) (P 250,00) (P 100,000) P 500,000

Required: Compute the income before personal exemptions in 2015.

Solution:
2013 2014 2015
Net income (NOLCO) (P 250,000) (P 100,000) P 500,000
2013 NOLCO applications 100,000 ( 100,000)
Net income P - P 400,000

Note:
1. The P250,000 net operating loss occurred in a year when the taxpayer was tax exempt. This
operating loss cannot be carried over as NOLCO.
2. The P100,000 net operating loss occurred in a year when the taxpayer was taxable. This
operating loss can be carried over as NOLCO. Hence, this is carried over as deductions in 2015.

Rationale of the Disallowance of Carry-Over of Net Operating Loss

Deductions are of no benefits to the taxpayer in an exempt year. Hence, the net operating loss
(i.e., excess deduction) from an exempt year should not be given value by carry-over as this
would cause undue enrichment to the taxpayer.

Illustration 1: Substantial change in ownership

Mr. See own 80% of Trinoma Corp. Inc 2016, Mr. See disposed of his 80% interest to Mr.
Yuchen. The net income and (loss) of Trinoma Corporation since 2014 were:
2014 2015 2016
Net income (NOLCO) (P 250,000) P 150,000 P 500,000

Required: Compute the 2015 and 2016 taxable net income of Trinoma Corp.
Solution:
2014 2015 2016
Net income (NOLCO) (P 250,000) P 150,000 P 500,000
2014 NOLCO application 150,000 ( 150,000)
( 100,000) ( 0)

Taxable net income P 0 P 500,000

Note: NOLCO carry-over is allowed in 2015 since there is no substantial change in ownership
but not allowed in 2016 since there is change in at least 75% in the ownership of the business.

Illustration 2: Substantial change in ownership

Mr. Tan started a business in 2014. Disheartened by heavy losses, he sold the business to Mr.
Song at the start of 2015. The net income or (loss) of the business were.
2014 2015 2016
Net income (NOLCO) (P 800,000) (P 300,000) P 500,000

Required: Compute the taxable net income of the business in 2016

Solution:
2014 2015 2016
Net income (NOLCO) (P 800,000) (P 300,000) P 500,000
2015 NOLCO Application 300,000 300,000
( 0)
Taxable net income P 200,000

Note: The 2014 NOL cannot over since there is a substantial change is ownership is 2015.

Rationale of the Rule on Substantial Change in Ownership

NOLCO is granted as an incentive to taxpayers to enable them to recoup their losses before
they become fully subject to income tax. Without this incentive, income tax would become a
tax on capital.

When there is a substantial change in the ownership of the business, NOLCO is no longer
allowed because the owners for whom the loss recoupment is intended are no longer in the
business. In other words, NOLCO is a privilege that is not transferable.

Due to the foregoing rules, it must be emphasized again that the occurrence of a net operating
loss in prior years does not automatically mean that there is a NOLCO.

Rules in Carry-Over of NOLCO

1. NOLCO is claimable in a first-in-first-out (FIFO) fashion.
2. NOLCO can be claimed only up to the extent of the business net income in the next three
years. Prior year NOLCO cannot be deducted against a subsequent year net operating loss.
3. Any NOLCO which remains unused at the end of the three-year prescriptive period will
expire.

Illustration 1
2012 2013 2014 2015 2016
Gross income P 400 P 320 P 480 P 400 P 500
Less: Deduction 500 450 450 340 340
Net income ( 100) (P 130) P 30 P 60 P 160

In 2013
The taxable net income is nil. No deduction can be made against a subsequent net operating
loss since this will roll over the NOLCO through integration in the net operating loss of the
following year. This will effectively breach the three-year prescriptive period rule.

In 2014
The taxable net income is nil. The 2012 NOLCO application and the remaining NOLCO prior
year balance as December 31, 2014 are:
2012 2013 2014
Net income (P 100) (P 130) P 30
2012 NOLCO application 30 ( 0)
Net income (NOLCO balance) (P 70) (P 130) P 0

Note: Deduction for NOLCO can be made only to the extent of available net income in the tree
following years.

In 2015
The taxable net income is nil. The 2012 NOLCO application and the ending NOLCO prior year
balance of December 31, 2015 are:
2012 2013 2014 2015
Net income (NOLCO) (P 70) (P 130) P 0 P 60
2012 NOLCO application 60 ( 60)
Net income (NOLCO balance) (P 10) (P 130) P 0 P 0

Note: The P10 excess 2012 NOLCO balance already expired because this is the third year. The
same can no longer be used as an item of deduction in future year.

In 2016
The taxable income is P30.
2013 2014 2015 2016
Net income (NOLCO) (P 130) P 0 P 0 P 160
2013 NOLCO application 130 ( 130)
Net income (NOLCO) P 0 P 0 P 0 P 30

Illustration 2
A domestic operations reported the following results of operations from years 2011 through
2016:
2011 2012 2013 2014 2015 2016
Gross income P 410 P 300 P 500 P 400 P 600 P 900
Less: Deduction 500 500 450 360 450 500
NI/(NOLCO) ( 90) ( 200) P 50 P 60 P 150 P 400

The taxable net income of the corporation from years 2011 throughout 2016 shall be
computed as follows:

2011 2012 2013 2014 2015 2016

NI/ (NOLCO) (P 90) (P 200) P 50 P 60 P 150 P 400
50 ( 50)
NOLCO balance ( 40) ( 200)
40 ( 40)
( 200) P 20
20 ( 20)
NOLCO balance ( 180)
150
( 150)
P 30 Expired ( 0)
Net income P - P - P - P - P - P 400

NOLCO FOR INDIVIDUAL TAXPAYERS

NOLCO refers to an operating loss from business or exercise of a profession. For individual
taxpayers, NOLCO is not equivalent to negative taxable income. A negative taxable
compensation income is not NOLCO.

Illustration
As individual taxpayer complied the following income, expense and personal exemptions.
2013 2014 2015 2016
Compensation income P 20,000 P 220,000 P 80,000 P 75,000
Business gross income 470,000 400,000 500,000 500,000
Deductions 500,000 420,000 420,000 340,000
Personal exemptions 50,000 50,000 100,000 125,000
Required: Determine the annual taxable income.

Solution:
2013 2014 2015 2016
Compensation income P 20,000 P 220,000 P 80,000 P 75,000
Less: Personal exemptions 50,000 50,000 100,000 125,000
Taxable comp. income (P 30,000) P 170,000 (P 20,000) (P 50,000)

Business gross income P 470,000 P 400,000 P 500,000 P 500,000

Less: Deductions 500,000 (420,00) 420,000 340,000
Net income (NOLCO) (P 30,000) (P 20,000) P 80,000 P 160,000

30,000 20,000 (50,000) _______

- - P 30,000 P 160,000

Taxable Income P 0 P 170,000 P 10,000 P 110,000

Note:
1. As a rule, the taxable compensation income and the net income are simply combined in
computing the taxable income of individual taxpayers.
2. A negative taxable compensation income is deductible against net income but cannot be
carried over.
3. A not operating loss from business or exercise of profession is not deduction from taxable
compensation income, but is carried over as NOLCO.

Special Rule on NOLCO for Mining Companies

The net operating loss sustained by mining companies without the benefits of incentives under
the Omnibus investment Code of 1987 in any of their first 10 years of operation is allowed to
be carried over a period of 5 years following the years the net operation loss was sustained.

NOLCO and Net Capital Loss Carry Over

NOLCO is deductible against available net income in the three years of operation. Net capital
loss carry-over is deductible only up to the extent of the net capital gain the immediately
following years.

Net Capital Carry-Over cannot be claimed simultaneously with NOLCO. Is accordance with the
income tax benefits rule, no capital loss carry-over is allowed when the year’s operation
resulted in a net operating loss (Le. Limit 1 is zero)
Merger and Consolidation
Merger occurs when one business is merged with another business. Consolidation occurs when
several business merge to form a new larger business. The acquired business is referred to as
“assignor” or “transferor” and the purchaser as the “transferee” or

“Assignor” and the purchaser as the “transferee” or “assignee”. In assignor is called the
“acquire” while the purchaser is called “acquirer”.

NOLCO and Merger or Consolidation NOLCO of the Acquirer

Under RR14-2001, the NOLCO of the acquirer which incurred before the merger or
consolidation continues to be deductible even after merger or consolidation so long as the
there is no substantial change in its ownership.

NOLCO of the Acquire

Historically, the BIR consistently ruled that NOLCO is transferrable to a surviving corporation
since it is viewed as part of the rights, privileges, properties and the interests that will be
transferred to and vested in the surviving corporation upon merger or consolidation.

However, under BIR Ruling 214-2012, the BIR ruled that NOLCO is not one of the assets of the
absorbed corporation that can be transferred and absorbed by the surviving corporation,
nothing that is privilege or deduction that can be availed only by the absorbed corporation.

Under Sec. 34 (D) (3) of the NIRC, NOLCO is not allowed as deduction when there is a
substantial change in the ownership of the business. It is clear that the privilege loss was
incurred while denying it to the new group of owner who subsequently acquired substantial
interest in the business. Thus, NOLCO is needed not a transferrable right, privilege, or
interest.

BIR Ruling 214-2012 was rendered in the context of an exempt merger where the context of an
exempt merger where the combining companies are owned by the same shareholders’ group.
However, it is expected to be emphasized finally that an acquirer cannot claim the NOLCO of
the acquired business.
CHAPTER 14

REGULAR INCOME TAXATION: INDIVIDUALS

Chapter Overview and Objectives

This chapter focuses on the regular income taxation of individual taxpayers and provides an
integration of all income tax rules relevant to individual taxpayers. It discusses the rules on
personal exemption and the procedures for filling of individual income tax returns.

After this chapter, readers are expected to demonstrate mastery on the following.

1. Special rules on married taxpayers

2. Rules on personal exceptions
3. Rules in change in statues
4. Rules relevant to taxable estates or trusts
5. Conditions of the substituted filing system
6. Conditions when to prepare a consolidated or adjustment return
7. Computation of the estimated tax payments for individual engaged in business
8. Rules on installment payment of the regular tax

INDIVIDUAL INCOME TAXATION

The final tax and capital gain tax of individual taxpayers have been discussed in the previous
chapter. This chapter focuses advanced regular rules applicable to individual income taxpayers.

Coverage of Progressive Income Tax

The progressive income tax for individuals covers all individuals subject to tax on taxable
income, such as following:

1. Citizens
a. Resident citizens
b. Non-resident citizens
2. Aliens
a. Residents Alien
b. Non-residents alien engaged in business
3. Taxable estate
4. Taxable trust
THE REGULAR TAX MODELS FOR INDIVIDUALS

Gross compensation income P xxx, xxx

Less: Personal exemptions xxx,xxx
Taxable compensation income P xxx, xxx
Gross income from business/profession P xxx, xxx
Less: Deductions xxx, xxx
Net income P xxx, xxx
Taxable Income P xxx, xxx

THE PROGRESSIVE TAX TABLE

The income tax due of individual taxpayers is determined based on the following scheduler tax
rates:

If taxable
Income is over But not over Basic Tax Plus % Of excess over
P 0.00 P 10,000.00 P 0 5% P 0.00
10,000.00 30,000.00 500 10% 10,000.00
30,000.00 70,000.00 2,500 15% 30,000.00
70,000.00 140,000.00 8,500 20% 70,000.00
140,000.00 250,000.00 22,500 25% 140,000.00
250,000.00 500,000.00 50,000 30% 250,000.00
500,000.00 125,000 32% 500,000.00

PERSONAL EXEMPTIONS
Personal exemptions are the theoretical personal, living, and family expenses allowed to be
deducted from the gross or net income of an individual taxpayer. These are arbitrary amounts
which have been calculated by our lawmakers to be roughly equivalent to the minimum of
subsistence, taking into consideration the personal status and qualified dependents of the
taxpayer. (Pansacola vs.CIR, G.R 159991)

Who can claim personal exemptions?

All individual taxpayers’ subjects to progressive tax can claim personal exemptions. Individuals
subjects to final tax such as NRA-NETBs and special aliens are not allowed personal exemptions.

Types of Personal Exemptions

1. Basic personal exemptions

2. Additional personal exemptions
3. Premium for health and hospitalization insurance
BASIC PERSONAL EXEMPTION RA 9504 (new) RA 8424 (old)
1. Single, including separated spouse without
a dependent, widow or widower P 50,000 P 20,000

2. Head of the family 50,000 25,000

3. Married 50,000 32,000
4. Taxable estate or trust 20,000 20,000
ADDITIONAL PERSONAL EXEMPTIONS
For every dependent not exceeding four P 25,000 P 8,000

A head of the family is an unmarried or legally separated man or woman with one or both
parents, or with one or more brothers or sisters, or with one or more legitimate, recognized
natural or legally adopted child, senior citizens or persons with disability dependent upon him
for either their chief support.
Requisites of Claimable Dependents:
1. A legitimate, legally adopted, recognized natural or illegitimate child including:

a. Foster child, and

b. Persons with disability (PDW)

2. Living with the taxpayer and dependent upon him for chief support
3. Not more than 21 years old, unmarried, and not gainfully employed
4. Regardless of age, if incapable of self-support because of mental or physical defect
The term “chief support” means not just partial but principal or main support. The taxpayers
must be providing more than 50% of the child’s need for subsistence.

The phrase “living with the taxpayer” is merely a collaborating test of dependency and does not
presuppose physical togetherness. For instance, a child living with his grandparents and not
with his parents may mean he may not be actually dependent on his parents. This criterion is
deemed satisfied if chief support is proven. Hence, a dependent who is studying and living
abroad is still claimable as additional personal exemption.

A Foster Child is child placed under planned temporary substitute parental care (foster care) by
a person duly licensed by the DSWD to provide foster care (foster parent) pursuant to the
Foster Care Act of 2012.
Persons with disability (PWD)

Disabled Persons are those suffering from restriction of different abilities, as a result of a
mental, physical or sensory impairment, to perform an activity in the manner or within the
range considered normal for a human being.

Impairment is any loss, diminution or aberration of psychological, physiological or anatomical

structure of function.

Disability shall mean a physical or mental impairment that substantially limits one or more
psychological, physiological or anatomical function of an individual or activities of such
individual, a record of such an impairment; or being regarded as having such an impairment.

Under RA 10754, disabled persons who are within fourth civil degree of consanguinity or
affinity to the taxpayer, regardless of age, who are not gainfully employed and chiefly
dependent upon the taxpayers as now claimable as additional exemptions. Previously, a
benefactor of a PWD is entitled to additional exemption only if he or she is parent of the PWD.

Who is the claimant of additional exemption?

The proper claimant of additional exemption is the husband unless he waived his right in favor
of the wife. If only of the spouses derives gross income subjects to regular tax, only such spouse
shall be allowed the personal exemptions.

Hence, where one of the spouses is unemployed or is a non-resident citizen deriving income
from foreign sources, the employed spouse or the resident spouse within the Philippines as the
case may be, shall be automatically entitled to claim the additional exemptions for the children.

Also, when one of the spouses is deriving income from pure passive sources subject to final tax,
the spouse with income subject to regular tax shall be the claimant of the additional personal
exemptions.

ILLUSTRATION 1
Ms. Lovely Landy is single with five dependent children.
She shall be allowed the following personal exemption:

Basic personal exemption P 50,000

Additional personal exemption (4 max. x P25,000) 100,000
Total personal exemption P 150,000
Illustration 2
Mr. and Mrs. Aparri are both employed and have the following dependent children:

Jazmine 27 years old, married and unemployed

Ramon 25 years old, mentally retarded
John 23 years old, unmarried and unemployed
Rhad Vic 21 years old, married and unemployed
Rodolfo 18 years old, unmarried and employed
Czarina 16 years old, college student with boyfriend
Ramsay 14 years old, high school student

Mr. and Mrs. Aparri can claim the following personal exemptions:

Mr. Aparri Mrs. Aparri

Basic personal exemption P 50,000 P 50,000
Additional personal exemption

(Ramon, Czarina and Ramsay) 75,000 -

Total personal exemption P 125,000 P 50,000

Illustration 3
Ms. Dona supports the following dependents:

Kareen 12 years old, foster child, not related by blood

Rennie 15 years old, mentally retarded godson
Mark 21 years old, boyfriend
Mamang 70 years old, sole surviving parents of Ms. Dona
Romeo 45 years old first cousin, a disabled person
Tony 64 years old, uncle

Ms. Dona will be allowed basic personal exemption plus aP50,000 additional exemptions (i.e.,
Karen and Romeo). Romeo is a PWD within fourth degree of consanguinity.

Note: In determining degree of consanguinity, we count the number of generation up to the

common ancestor of the taxpayer and the PWD then down to the PWD: Ms. Dona to her
parents (1), her parents to grandparents (2), grandparents to Romeo’s parents (3), then
Romeo’s parents to Romeo (4), Hence, Romeo is within fourth degree of consanguinity.

Illustration 4
Mr. Wong, a Chinese national, is employed as manager in the ROHQ of a multinational
company established in the Philippines. He has three minor dependent children.
Mr. Wong cannot claim any personal exemption because he is a special alien.
Legally separated spouses
In case of legally separated spouses, additional exemption may be claimed by the spouses
having custody of the children, provided that the total amount of additional exemptions that
may be claimed by both shall not exceed the maximum additional exemptions allowed.

Dependent senior citizens

Under the Expanded Senior Citizen’s Act, benefactors of senior citizens can claim them as
dependents. However, RR4-2006 clarified that senior citizens entitles their benefactors to a
P25,000 basic exemptions allowed to head of the family instead of the P20,000 basic
exemptions allowed to single taxpayers at the time. RR4-2006 expressly provided that
benefactors of senior citizens cannot claim additional exemption for senior citizens.

Considering the inconsistency, we shall follow the regulations until amended by the BIR,
repealed by subsequent legislation or reversed by the court. It should be clarified at this point
that persons with disability can be claimed as additional dependent but not senior citizens.
Senior citizens may be claimed only as additional dependent if they qualify also as person with
disability.

RULES OF CHANGE OF STATUS

1. If the taxpayers should have additional dependent(s) during the year, the taxpayer may claim
the corresponding additional exemption in full for such year.
2. If the taxpayer dies during the year, his estate may still claim the personal and additional
exemption for himself and his dependents as if he died at the close of such year.
3. If any of the dependents dies, marries, becomes 21 years old, or becomes gainfully employed
during the taxable year, the taxpayer may still claim the same exemption as if the event
occurred at the end of the year.

Illustration 1: Increase in claimable dependents

As of December 23, 2013, Mr. Caticlan, a resident citizen, has the following dependents:

Matthew 2 months old baby

Mark 1 years old legally adopted child during the year
Luke 17 years old, high school boy
Jacob 19 years old, college student

Mr. Caticlan can claim the following exemptions

Basic personal exemption P 50,000

Additional personal exemption (P25,000 x 4) 100,000
Total personal exemption P 150,000
Legal adoption is a mode of acquiring new dependents aside from natural birth. The taxpayer
shall claim the full additional personal exemption for the newly acquired dependents during the
year.

Illustration 2: Loss of claimable dependents

Mr. Oxibala has the following dependents at the end of 2013

Name Status
John 18 years old, college student, got married on March 4, 2013
Kevin 20 years old, became employed since December 26, 2012
Methuselah 21 years old, adopted child, graduating college student
Alexander 23 years old, died from a stray bullet on New Year’s Eve

Only John and Mathusalem are claimable, Methuselah just became more than 21 years old
during the year. He is still claimable under the rules. Note that Kevin is employed throughout the
years 2013 since he got employed last year. The death of Alexander is not a change in personal
exemption as it a loss of a non-claimable dependents.
The 21-years old rule
It is by universal traditional that we count age by years. Never did we count age by fractions
such as 21-92 years old. A dependent that is 21 years old and 11 months old is still 21 years old.
The phrase “more than 21 years old” should means 22 years old. However, the regulation is
very strict. Once a dependent becomes 21 years old during the years, he is considered more
than 21 years old but still claimable under the rules of change in status. A dependent who
became 22 years old during the years is no longer claimable unless he is mentally or physically
incapacitated.

Income and deductions of a deceased taxpayer

In the case of the death of the taxpayer, there shall be included in computing taxable income
for the taxable period in which falls the date of his death, amounts accrued up to the date of
this death if not otherwise properly includible in respect of such period or a prior period. (Sec.
44, NIRC)

In case of the death of a taxpayer, there shall be allowed as deductions for the taxable period in
which falls the date of his death, amounts accrued up to the date of his death if not otherwise
properly allowable in respect of such period or a prior period. (Sec. 45, NIRC)

Illustration
Mr. Mabait died on August 30, 2014. He was survived by his wife and his two children. Before
his death, he had a P400, 000 business net income. His estate underwent judicial proceeding.
From August 31, 2014 to December 31, 2014, the business posted P200, 000 net incomes.
The income of Mr. Mabait from January 1 to August 30, 2014 will be reported in an income tax
return under his name. His personal exemption and taxable income shall be as follow:

Net income (January 1 to August 30, 2014) P 400,000

Less: Personal exemptions
Basic P 50,000
Additional (P25,000 x 2) 50,000 100,000
Taxable income P 300,000

The accounting period of the deceased shall be terminated at the date of the death. Net
income will be cut off for tax reporting as of that date; however, the claimable personal
exemption of the decedent shall be determined as if he died at year-end.

The income of Mr. Mabait after his death will be reported by his state. The personal exemption
and taxable income of the estate shall be:

Net income (August 32 to December 2014) P 200,000

Less: Personal exemptions 20,000
Taxable income P 180,000

If the estate of Mr. Mabait is settled extra-judicially, his heirs will repot their share in the P200,
000 net incomes in their individual tax returns.

PERSONAL EXEMPTION OF NON-RESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS

Under RR2-98, NRA-ETB can claim only a basic personal exemption subject to the following
reciprocity conditions:
a. The country to which the NRA-ETB is a citizens must have an income tax law.
b. The income tax law of the country of the NRA-ETB allows personal exemptions to citizens of
the Philippines not residing therein.
c. The NRA-ETB files a true and accurate return of his income from all sources within the
Philippines.

Illustration
Mr. Bansai is an NRA-ETB with four qualified dependents. His country allows marries individuals
basic personal exemptions equivalent to P40, 000 and P20, 000 additional exemptions per
dependent not exceeding five.

Mr. Bansai can only claim a basic personal exemption of P40, 000 as allowed in his country
which is lower than the P50, 000 basic personal exemption allowed in the Philippines.

Interestingly however, a closer examination of section 3D (D) of the NIRC reveals a different
story:
(D) Personal Exemption Allowable to Non=resident Alien Individual- A non-resident alien
individual engaged in trade or business or in the exercise of a profession in the Philippines shall
be entitled to personal exemption in the amount equal to the exemptions allowed in the
income tax law in the country of which he is a subject- or citizen, to citizens of the Philippines
not residing in such country, not to exceed the amount fixed in this section as exemption for
citizens or resident of the Philippines. XXX” (Emphasis and underscoring supplied)

Section 35 of the NIRC entitled “Allowance of Personal Exemption for Individual Taxpayer”
includes the following subsections:

 Subsection A – In general. Xxx, there shall be allowed a basic personal exemption

of…xxx
 Subsection B- Additional exemption for dependents- There shall be allowed an
additional exemption of…xxx
 Subsection C- Change of status
 Subsection D – Personal exemption of NRA-ETB

Sec. 35 of the NIRC used term “personal exemption” to include a basic personal exemption and
an additional exemption. Basic personal exemption and additional personal exemption are not
separate concepts. Since the “personal exemption” referred to under Sec. 35 (D) pertains to one
and the same thing. It should be construed to include a basic personal exemption and an
additional personal exemption and an additional exemption, subject to reciprocity.

Illustration
Mr. Andrew, NRA-ETB has seven dependents in the Philippines. His country allowed basic
personal exemption of P80,000 and additional exemption equivalent to P30,000 per dependent
not exceeding six.

Andrew’s Country Philippines

Basic exemption P 80,000 P 50,000
Additional exemption P 30,000/dep. P 25,000/dep.
Allowed dependents 6 4
Total additional exemption P 180,000 P 100,000
Allowable personal exemption P260,000 P150,000

Pursuant to the NIRC, the allowable personal exemption should be P150, 000. But under the
regulations, the allowable personal exemption is only P50,000.

Note to Readers
While RR2-98 seems to have altered the provision of the law, it shall be followed unless
subsequently revised, amended or set aside. The power to interpret the provisions of the NICR
and other tax laws is under the exclusive and original jurisdiction of the CIR, subject to review
by the Secretary of Finance. Revenue regulations and rulings are presumed valid interpretations
of the law unless challenged and reversed before the courts. To this date, no court decision has
ever set aside the treatment specified by RR2-98.

PREMUIM ON HEALT AND/ OR HOSPITALIZATION INSURANCE

The premiums on health and or hospitalization insurance (PHHI) paid by the taxpayer for
himself including his family not exceeding P200 a month or P2,400 a years, shall be claimed as
deduction against gross income provided that the family income of such taxpayer shall not
exceed P250,000 for the taxable year.

Who are allowed to deduct PHHI?

PHHI is claimable by all individual taxpayers subject to progressive tax except non-resident alien
engaged in the trade or business (NRA-ETB).

Requisites of deduction for PHHI

1.Deduction shall not exceed P200/month or P2,400 a year.
2. Total family income shall not exceed P250, 000.
3. Deduction is claimable by the spouse who actually paid the premiums.
4. Deduction is allowed to the spouse claiming the additional exemption.
To qualify for this deduction, the employee shall present the policy contract together with the
original receipt of the premium payment for the current year to the employer.

Total family income includes primary and other income from sources received by all members
of the nuclear family, .ie,.father, mother, unmarried children living together as one household,
or a single parent with children. A single person living alone is considered as a nuclear family.
Illustrative 1
Ms. Beauty single, got employed in August 2016 with a monthly salary of P20,000. She paid
P400 monthly premium on health insurance expense or a total of P2,000 in 201.

Ms. Beauty can claim a deduction for premium for health insurance since her income in 2016 did
not exceed the annual threshold. The deductible amount shall be P1,000 computed as
P200/month x 5 months or P1,000.
Illustration 2
Mr. Perez is unmarried with an annual income of P248, 000, net of P4, 000 premium payments
on hospitalization insurance.

Mr. Perez cannot premium for health and hospitalization insurance as his real income (248,000
+P4,000) already exceeds the income threshold.
Illustration 3
Mr. and Mrs. Antique, both engaged in business, have three dependents. The spouses have a
combined income of P240,000 during the year. Mrs. Antique paid P3, 000 annual premiums for
health insurance.

None of the spouses can claim deduction for premium or hospitalization insurance. Mr. Antique
is the proper claimant of additional exemption. He could not be allowed to claim PHHI because
he did not pay for the same.

Assuming that Mr. Antique waived his right to claim additional personal exemptions in favor of
Mrs. Antique, Mrs. Antique will claim the additional exemption including the PHHI, but only in
the amount of P2,400.

Illustration 4
Mr. and Mrs. Bohol have two dependent children. They have the following compensation
income and payments for premium on health and hospitalization insurance;

Mr. Bohol Mrs. Bohol

Compensation income P 110,000 P 140,000

Premiums for hospitalization
and or health insurance 2,000 3,000
The spouses shall claim the following personal exemptions:

Mr. Bohol Mrs. Bohol

Basic personal exemption P 50,000 P 50,000
Additional (25,000x2) 50,000
PHHI (lower of 2,400 and 2,000) 2,000
Total personal exemption P 102,000 P 50,000
Assuming Mr. Bohol waived his right to claim additional exemption in favor of this wife the
spouses shall claim the following personal exemptions:

Mr. Bohol Mrs. Bohol

Basic personal exemptions P 50,000 P 50,000
Additional (25,000x2) - 50,000
PHHI (lower of 2,400 and 3,000) - 2,400
Total personal exemption P 50,000 P 102,400
TAXABLE ESTATES AND TRUSTS
Taxable Estates
An estate is an income taxpayer if under judicial settlement or administration. A taxable estate
is treated as an individual taxpayer and is allowed P20,000 personal exemption.

An estate under extra-judicial settlement is not a taxpayer. The income of the estate is taxable
to the heirs.
Taxable Trusts
A revocable trust is not a taxpayer and is treated as a pass through entity whose income is
taxable to the grantor- trust or.

An irrevocable trust is a separate and distinct taxable entity (BIR Ruling 003-035 July 22,2005).

A taxable trust is treated as an individual taxpayer and is allowed P20, 000 personal
exemptions.
Income taxable to an estate or trust under the NIRC
1. Income accumulated in trust for the benefit of unborn unascertained person or persons with
contingent interests and income accumulated or held for future distribution under the terms of
the will or trust.
2. Income which is to be distributed currently by the fiduciary to the beneficiaries and income
collected by a guardian of an infant which is to be held or distributed as the court may direct
3. Income received by states of deceased persons during the period of administration or
settlement of the estate
4. Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries
or accumulated.

Illustration: Estate
The estate of Mr. Barbel has P800, 000 gross incomes before business expenses of P200,000.
The estate administrator distributed P300,000 to the heirs in accordance with the will of Mr.
Barbel.

The taxable income of the estate will be computed as follows:

Gross P 800,000
Regular allowable deduction P 200,000
Special allowable deductions
Income Distribution to heirs 300,000 500,000
Net income P 300,000
Net income P 300,000
Less: Personal exemptions 20,000
Taxable income P 280,000
Note:
1. It must be recalled that income distribution from the estate is a special deduction against the
gross of the estate.
2. The heirs shall include the P300,000 income distribution in their taxable income.

Illustration: Trust
Mr. Batman designed in irrevocable trust a property in favor of Robin and appointed Superman
as trustee. The property earned P500,000 incomes before expenses of P200,000 and trust fees
of P50,000. In accordance with the trust indenture, Superman distributed P100,000 to Robin.

The taxable income of the trust shall be computed as follows:

Gross income P 500,000
Less:
Regular allowable deductions P 250,000
Special allowable deduction
Income distribution to beneficiaries 100,000 350,000
Net income P 150,000
Less: Personal exemption 20,000
Taxable income P 130,000

Note: Robin will report P100,000 income distribution in his taxable income. Superman will
report the P50,000 trust fees in his gross income.

Consolidation of two or more trusts

Multiple irrevocable trusts designated by the same grantor for the benefit of the same
beneficiary shall be consolidated for purposes of income tax.

The consolidation of irrevocable trusts is necessary to eliminate tax savings which the grantor
may derive by deliberately splitting the corpus of the trusts into several trusts.

Illustration 1
Don Ambrocio designated three trusts all in favor of his daughter, Cindy:

Operating Distribution
Trust Designation Trustee income to Cindy
Trust 1 Irrevocable AJ P 200,000 P 20,000
Trust 2 Irrevocable BJ 300,000 30,000
Trust 3 Revocable CJ 200,000 40,000

The trustees of Trust 1 and Trust 2 shall prepare tax returns covering the income of the
property held under their control as follows:

Trust 1 Trust 2
Operating income P 200,000 P 300,000
Less: Special itemized deduction
Income distribution to beneficiary 20,000 30,000
Net income P 180,000 P 270,000
Net income P 180,000 P 270,000
Less: Personal exemptions 20,000 20,000
Taxable income P 160,000 P 250,000

Income tax due per tax table P 27,500 P 50,000

For purpose of income taxation, the income of Trust 1 and Trust 2 will be consolidated as
follows:

Consolidated
Trust 1 Trust 2 Trust
Net income P 180,000 P 270,000 P 450,000
Less: Personal exemptions 20,000
Adjusted taxable income P 430,000

Income tax due P 104,000

Less: Income tax paid P 27,500 P 50,000 77,500
Additional income tax payable P 26500

The additional tax payable resulting from the consolidation of two irrevocable trust will be
apportioned to Trust 1 and Trust 2 based on the following procedure:

Trust 1 (P160K/(160K+250K) x P104,000 - P27,500 = P 13,085

Trust 2 (P250k/(160k+250K) x P104,000 – P50,000 = 13,415
Total tax still due P 26,500

Trust 3 is not taxable as it is revocable. The entire P200,000 income of Trust 3 including the
P40,000 income distribution to Cindy will be included in the taxable income of Don Ambrocio.

Illustration 2: Trust with retention of certain rights

Mr. Masagana designated two trusts as follows:

Trust Beneficiary Designation

Irrevocable as to corpus and income, however, Mr.
Trust Cassandra Masagana reserves the power to revest to himself ¼ of
1 (daughter) the corpus upon the happening of some specified
contingencies
Irrevocable as to corpus and income except that P30,000
Trust Alexander of the annual income will be used to pay the life
2 (son) insurance premium of Mr. Masagana.

The Trust 1 and Trust 2 earned P200,000 and P300,000 during the year. Both trust made
distributions to their perspective beneficiaries amounting to P50,000 and P100,000,
respectively

The two trusts will not be consolidated because they involve separate beneficiaries. However,
the grantor shall include in his taxable income any income pertaining to that part of the corpus
over which the grantor has reserved power to revoke. Any income of trust reserved for the
benefit of the grantor shall likewise be included in the taxable income of the grantor.

The taxable income of Trust 1and Trust 2 shall be computed as follows:

Trust 1 Trust 2
Operating income P 200,000 P 300,000
Less: Special regular itemized deductions
Income pertaining to grantor *50,000 30,000
Distribution to beneficiaries 50,000 100,000
Net income P 100,000 P 170,000
Less: Personal exemptions 20,000 20,000
Taxable income P 80,000 P 150,000

Note:
1. The grantor has reserved power to revoke one quarter of the corpus in Trust 1.
2. The P50,000 income pertaining to such part, computed as (P200,000 x 1/4), shall be
taxable upon the grantor.
3. The P30,000 income which shall be reserved for the payment of the life insurance of the
grantor shall be likewise taxable to the grantor.

Employee trust funds

An employee’s trust which forms part of a pension, stock bonus, or profit sharing plan of an
employer for the benefit of some or all of his employees is example from income taxes imposed
under the NIRC. (Sec. 60(B), NIRC) It must be emphasized that this exemption covers final tax,
capital gains tax, and regular income tax.

Requisite of Exemption of Employee’s trust

1. Contributions are made to the trust by the employer, employees, or both for the purpose
of distributing to such employees the earning and principal of the fund accumulated by the
trust in accordance with such plan.
2. Under the trust instrument, it is impossible at any time prior to the satisfaction of all
liabilities with respect to employees under the trust, for any part of the corpus or income to be
(within the taxable year or thereafter) used for or diverted to purposes other than for the
exclusive benefit of his employees.
3. Any amount actually distributed to any employee or distributee shall be taxable to him in
the year in which so distributed to the extent that exceeds the amount contributed by such
employee o distribute.

FINAL TAX FOR CERTAIN INDIVIDUAL TAXPAYERS

It is noteworthy to recall also the following individuals subject to final tax:

1. Non-resident aliens not engaged in trade or business – subject to a 25% final tax on gross
income.

2. Special-aliens subject to 15% tax on gross income on all remunerations and emoluments
from their employers.

Illustration 1
Mr. Bombay, an unmarried alien, arrived in the Philippines on November 1, 2014. He lent
money to a local businessman earning him P200,000 interest income until December 31, 2014.

The income tax of Mr. Bombay shall be computed as P200,000 x 25% = P50,000. The same
should be withheld by the debtor who shall remit the same to the government. Mr. Bombay will
not be allowed to claim personal exemption because NRA-NETBs are subject to 25% final tax on
gross income.

Note that the test for the purpose of taxpayer classification is the length of residency, not the
actual engagement in business.

Illustration 2
Mr. Jolo is a married Filipino citizen with four dependent children. He is employed by an
offshore banking unit of a multinational company in the Philippines and derives annual
compensation income of P1,000,000.
Mr. Jolo’s income tax will be computed as P1,000,000 x 15% = P150,000. He will not be allowed
to claim personal exemptions because he is subject to final 15% tax on gross income.

Illustration 3
Mr. Patikul, single Filipino citizen with one dependent child, is a managerial employee in the
Regional Are Headquarters of PH Care International, a multinational corporation. He earned
P800,000 annual compensation.

Mr. Patikul shall be subject to the progressive income tax. Recall that a Filipino employee must
have at least P975,000 annual compensation income to be qualified as a special alien.

EMPLOYED TAXPAYERS: THE SUBSTITUTED FILING OF TAX RETURN

Employers are mandated to withhold income tax upon compensation income of their
employees. If the employee has no other sources of income subject to regular tax and the tax is
properly withheld, there would be no need for the employee to file an income return.

Under this condition, the tax withheld by the employer becomes effectively final for the year.
This is referred to as the substituted filing system.

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
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. The CWT withheld by
the employer shall be credited against the annual income tax due of the employee.

CONSOLIDATED RETURNS OF EMPLOYED TAXPAYERS

Employed taxpayers who derive other income subject to regular tax other than from a single
employment, and self-employed taxpayers must file an annual income tax return to include
their other income.

The filing of a consolidated, annual or adjustment return is required under each of the following
circumstances:

1. Concurrent employment during the year.

2. Successive employment during the year.
3. Receipt of income distribution from a general professional partnership, taxable trust, or
taxable estates, exempt co-ownership or exempt joint ventures.
4. Taxpayers with both employment income and business income

Illustration 1: Concurrent employment

Raymund was both employed in Yousee and in Youbee. He has the following income and
withheld tax during the year:
Yousee Youbee
Compensation income P 450,000 P 350,000
Personal exemptions 50,000 0
Taxable income P 400,000 P 350,000

Withheld tax P 95,000 P 65,000

Raymund’s consolidated income tax shall be computed as follows:

Compensation income (P450,000+P350,000) P 800,000

Less: Personal exemption 50,000
Taxable income P 750,000

Tax due of P750,000, per individual tax able P 205,000

Less: Tax withheld by employers (P95,000+P65,000) 160,000
Income tax payable or (refundable) P 45,000

Illustration 2: Successive Employment

In 2016, Zeus resigned from Blue Moon Company and transferred employment to Gagamba
Company. The following were his income.

Blue Moon Gagamba

Compensation income P 250,000 P 200,000
Tax withheld from compensation 62,500 50,000

At the year-end of 2016, Zeus should file a consolidated return covering 2016 and pay the
corresponding tax as follows:

Compensation income (P250,000+P200,000) P 450,000

Less: Personal exemption 50,000
Taxable income P 400,000

Tax due of P400,000 per individual tax table P 95,000

Less: Tax withheld by employers 112,500
Income tax payable or (refundable) (P
17,500)

The same consolidation procedures in the annual return shall be applied to other cases of receipt
of other income subject to regular income tax.

SELF-EMPLOYED TAXPAYERS AND THE QUARTERLY TAX RETURNS

Individual taxpayers engaged in business or practice of profession shall file, in addition to the
annual income tax return (BIR Form 1701), three quarterly income tax returns (BIR Form
1701Q) on or before the following dates.

Quarterly Tax Returns Deadline

1st Quarter ITR April 15 of the same calendar year
2nd Quarter ITR August 15 of the same calendar year
3rd Quarter ITR November15 of the same calendar year

Illustration
Mr. Henry, a self-employed taxpayer with a personal exemption of P50,000, has the following
quarterly gross income and deductions:

Jan. to March April to June July to Sept. Oct. to Dec.

Gross income P 200,000 P 250,000 P 220,000 P 280,000
Deductions 100,000 130,000 120,000 140,000
Withholding tax 2,000 10,000 8,000 14,000

Required: Determine his quarterly and annual income tax due and payable.

Solution:
The quarterly net income of individuals shall be determined on a cumulative basis, but without
deduction for personal exemptions. The personal exemptions are taken only in the annual
return.

1st Qtr. 2nd Qtr. 3rd Qtr. Annual ITR

Gross income P 200,000 P 250,000 P 220,000 P 280,000
Less: Allowable deductions 100,000 130,000 120,000 140,000
Net income, this quarter P 100,000 P 120,000 P 100,000 P 140,000
Add: income, prior quarters 0 100,000 220,000 320,000
Net income, to date P 100,000 P 220,000 P 320,000 P 460,000
Personal exemptions 50,000
Taxable income P 410,000

The income tax payable per quarter shall be computed as follows:

Income tax due per tax table P 14,500 P 42,500 P 71,000 P 98,000
Less: Tax credits
CWT this quarter P 2,000 P 10,000 P 8,000 P 14,000
CWT prior quarter 0 2,000 12,000 20,000
Total credits P 2,000 P 12,000 P 20,000 P 34,000
P 12,500 P 30,500 P 51,000 P 64,000

Less: Estimated tax paid

In prior quarters 0 12,500 30,500 51,000
Quarterly tax payable P 12,500 P 18,000 P 20,500 P 13,000

Note:
1. The quarterly income tax due is determined from the cumulative net income of individuals
from the individual tax table.
2. Personal exemption is deducted only in the annual income tax return.

ANNUAL/CONSOLIDATED RETURN OF MIXED INCOME EARNERS

Illustration: Annual Consolidated Return

Assume the same data in the immediately preceding illustration except that Mr. Henry also
derived the following compensation income:

1st Qtr. 2nd Qtr. 3rd Qtr. Annual ITR

Compensation income P 120,000 P 120,000 P 120,000 P 120,000
CWT on compensation 18,500 18,500 18,500 18,500

Required: Compute the annual income due and payable.

Solution:
The quarterly income tax due of a mixed income earner is determined out of his business or
professional net income only excluding the quarterly compensation income. Similarly, the
personal exemption of the taxpayer shall be ignored in the quarterly tax return. The
compensation income is integrated only in the annual income tax return.
The taxable income of Mr. Henry shall be consolidated and shall be presented in the annual
income tax return as follows:

Gross annual compensation income P 480,000

Less: Personal exemption 75,000
Taxable compensation income P 405,000
Add: Net income from business
Gross income P 950,000
Less: Deductions 490,000 460,000
Taxable income P 865,000

The annual income tax due and payable shall be computed as follows:

Taxable income P 865,000

Less: Lower bracket 500,000 P 125,000
Residual income P 365,000
Incremental tax x32% 116,800
Income tax due P 241,800
Less: Tax credits
Total CWT on compensation P 74,000
Total CWT on business gross income 34,000
Quarterly estimated tax payments 51,000 159,000
Income tax due and payable P 82,800

Note:
1. The tax credits are the sum of all quarterly withholding or estimated payments during the
year.
2. The withholding tax on compensation and the creditable withholding tax on gross business
income and merely advances to the annual income tax due.
3. Since the income tax of individuals is determined through a progressive tax, consolidation
of regular income is necessary to properly reflect the tax.

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:

Return of Married Taxpayers

Married individuals shall file a return for the taxable year to include the income of both
spouses, computing separately their individual income tax based on their respective total
taxable income. Where it is impracticable for the spouses to file one return, each spouse may
file a separate return of income. If any income cannot be definitely attributed to or identified as
income exclusively earned or realized by either of the spouses, the same shall divided equally
between the spouses for the purpose of determining their respective taxable incomes.

Income of unmarried minors from property received from parents

The income of unmarried minors derived from property received from a living parent shall be
included in the return of the parent except when:
1. The donor's tax has been paid on such property.
2. The transfer of such property is exempt from donor's tax.

Return of Persons under Disability

If the taxpayer is unable to make his own return, the return may be made by his duly
authorized agent or representative or by the guardian or other person charged with the care of
his persons or property. The principal and his representative or guarding assuming the
responsibility of making the return shall be responsible for penalties provided for erroneous,
false, or fraudulent returns.

Signature in the return is presumed correct

The fact that an individual's name is signed to a field return shall be prima facie evidence for all
purposes that the return was actually signed by him.

ATTACHMENT TO THE ANNUAL INCOME TAX RETURN

For taxpayers claiming the itemized deduction, taxpayers shall fill-up an attachment form. The
attachment form shows the composition of the itemized deductions in the annual income tax
returns plus required disclosures by law or regulations. This is mandatory and shall be filed
together with the income tax return. The required attachments were discussed in Chapter 7.

THE ANNUAL INFORMATION RETURN

The Annual Information Return (AIR) is a document showing the detailed disclosure on various
items of income, expense, details of transfer of properties and comparative accounts balances.

The annual information return is required for:

1. Individuals and estates or trusts not engaged in business or those earning pure
compensation income, with sole earnings subject to final tax or whose sole income is exempt –
through BIR Form 1705 to be filed on or before May 15 of the following year.
2. Self-employed individuals, estates, and trusts engaged in business – through BIR Form
1701AIF to accompany the annual income tax return.

3. Corporations and partnerships in general – through BIR Form 1702AIF to accompany the
annual income tax return.

Pursuant to RNC No. 6-2001, corporations, companies, or persons whose gross quarterly sales,
earnings, receipts, or output exceed P 150,000.00 may file their annual income tax returns
accompanied by balance sheets, profit and loss statements, schedules listing income-producing
properties and the corresponding income therefrom, and other relevant statements duly
certified by an independent CPA in lieu of BIR Forms 1701AIF and 1702AIF.

WHEN AND WHERE TO FILE AND PAY

1. For Electronic filing and Payment System (eFPS) taxpayers

The return shall be e-filed and the tax e-paid on or before the 15th day of April of each year
covering the income for the preceding year using the eFPS facilities through the BIR website.

2. For Non-Electronic Filing and Payment System (non-eFPS) taxpayers

The return shall be filed and the tax paid on or before the 15 th day of April of each year
covering the income for the preceding year with:
a. Any authorized agent banks (AAB) located within the jurisdiction of the Revenue District
Officer (RDO) where the taxpayer is registered.
b. Revenue Collection Officer (RCO) under the jurisdiction of the RDO where the taxpayer is
registered, if there is no AAB

In case of “no payment returns,” the same shall be filed with the RDO where the taxpayer is
registered or has his legal residence or place of business in the Philippines or with the
concerned RCO under the same RDO.

A “No payment return” pertains to tax returns without tax payable such as those with negative
or zero taxable income, those with exempt or no operation during with the period, those with
tax creditable or refundable, or those with balance payable only on the second instalment.

3. For non-resident taxpayers

In case the taxpayer has no legal residence or place of business in the Philippines, the
return shall be filed with the office of the Commissioner or Revenue District Office No. 39,
South Quezon City.

INSTALLMENT PAYMENT OF THE REGULAR INCOME TAX

When the tax due is in excess of P2,000, individual taxpayers (except corporations) may elect to
pay the tax in two equal instalments:
a. The first installment shall be paid at the time the return is filed.
b. The second installment is due on or before July 15 following close of the calendar year.

If any instalment is not paid on or before the date fixed for its payment, the whole amount of
the tax unpaid becomes due and payable together with the delinquency penalties.
Illustration 1

An in individual taxpayer availing of the installment payment of his income tax had a tax due of
P10,000 in 2013. He made quarterly estimated tax payments of P2,400 and was withheld with
P2,000 in creditable withholding taxes.

The first installmet which shall be due upon filing of the annual income tax return on or before
April 15, 2014 shall be:

Tax due on first installment (P10,000/2) P 5,000

Less:
Creditable withholding taxes P 2,000
Quarterly estimated tax payments 2,400 4,400
Tax payable P 600

The second installment which shall be due on or before July 15, 2014 shall be:

Tax due on first installment (P10,000/2) P 5,000

Illustration 2
An individual taxpayer availing of the installment payment of his 2013 income tax had a tax due
of P7,000 and was subjected to creditable withholding tax of P4,000
The first installment is nil. The taxpayer shall file a return, but with no payment.

Tax due on first installment (P7,000/2) P 3,500

Less: Creditable withholding tax 4,000
Tax payable (P 500)

The second installment due on or before July 15, 2014 shall be:

Tax due on first installment (P7,000/2) P 3,500

Less: Excess withholding tax in the first installment ( 500)
Tax payable P 3,000

WHO SHALL FILE THE INCOME TAX RETURN?

1. A resident citizen engaged in trade, business, or practice of profession within and without
the Philippines.
2. A resident alien, non-resident citizen, or non-resident alien individual engaged in trade,
business, or practice of profession within the Philippines.
3. A trustee of a trust, guardian of a minor, executor/administrator of an estate, or any
person acting in any fiduciary capacity for any person where such trust estate, minor, or person
is engaged in trade or business.
4. An individual engaged in trade or business or in the exercise of their profession and
receiving compensation income as well.
WHO ARE NOT REQUIRED TO FILE INCOME TAX RETURN
1. Minimum wage earners
2. An individual whose gross income does not exceed his total personal and additional
exemptions.
3. An individual whose compensation income derived from one employer does not exceed
P60,000 and the income tax on which has been correctly withheld.
4. Individuals whose income has been subjected to final withholding tax such as in the case of:
a. Special aliens
b. Non-resident aliens not engaged in trade or business
5. Pure compensation earns qualifies under the substituted filing system

AMENDMENT OF INCOME TAX RETURN

The amounts indicated by the taxpayer in the income tax return are his assertions. The same are
deemed final unless amended by the taxpayer. The taxpayer can amend the income tax return
so long as no Letter of Authority for investigation is issued by the BIR for the examination of the
tax return.