Module 6

Deductions
Prepared by: Nelia I. Tomas, CPA, LPT

INCOME TAXATION Laws. Principles and Applications 2019 OBE Edition by Rex B. Banggawan
 Part 4
Optional
Standard
Deduction

INCOME TAXATION Laws. Principles and Applications 2019 OBE Edition by Rex B. Banggawan
Learning Objectives
After completing the lesson, the students will be able to
1. Understand the nature of the optional standard deduction (OSD).
2. Acquire knowledge of the taxpayers who can claim the OSD.
3. Comprehend the concept of operating income or revenue and a non-operating
income for individual taxpayers.
4. Master the computation of the OSD for individual taxpayers and corporate
taxpayers
5. Comprehend the rules of OSD for general professional partnerships and the
partners
OPTIONAL STANDARD DEDUCTION (OSD)
 It is in lieu of the itemized deductions including NOLCO allowable under the NIRC and
special laws.
 Under the OSD, the allowable deduction of the taxpayer is simply presumed as a
percentage of gross sales or receipt for individuals and gross income for corporations.
 However, it does not relieve the taxpayer of the responsibility to deduct withholding tax
on certain income payments as required by the NIRC.

Who can claim OSD?

OSD is a proxy for itemized deductions. As a rule, all taxpayers who are subject to tax on
taxable net income can claim deductions except the following:
a. Non-resident alien engaged in trade or business (NRA-ETB)
b. Taxpayers mandated to use itemized deductions
Mandatory itemized deductions (RR2-2014)
1. Corporations mandated to use the itemized deductions:
a. Exempt GOCCs and non-stock, non-profit corporations with no taxable
income
b. Those with income subject to special/preferential tax rates
c. Those with income subject to regular corporate income tax and
special/preferential tax
2. Individual taxpayers mandated to use the itemized deductions:
a. Exempt individuals under the NIRC and special laws with no other taxable
income
b. Those with income subject to special/preferential tax rates
c. Those with income subject to regular income tax and special/ income tax
3. Non-resident alien not engaged in trade or business
 The option to claim OSD must be signified in the income tax return, otherwise itemized
deduction is presumed.
 The option to elect OSD or itemized deduction must be made in the first quarter return.
Such election when made shall be irrevocable in the taxable year for which the return
is made.
 Shifting between OSD and itemized during the taxable quarters of the taxable year is
not allowed.
 Taxpayers who opted to claim OSD are not required to submit their statements with
their income tax return.
 Individual taxpayers opting to deduct OSD shall keep records pertaining to their gross
sales or gross receipts.
 Corporations opting to deduct OSD shall keep such records pertaining to their gross
income during the taxable year.
PERCENTAGE OF OPTIONAL STANDARD DEDUCTIONS
1. Individuals taxpayers - 40% of total sales/revenues/receipts/fees
a. Those selling goods under the accrual basis - 40% of gross sales
b. Those selling services under the cash basis - 40% of gross receipts
c. Those selling services under the accrual basis - 40% of revenue
2. Corporate taxpayers — 40% of gross income
Illustration 1
The income statement of a retailer of goods under the accrual basis of accounting is shown
below:
Sales, net of returns, allowances, and discounts P1,000,000
Less: Cost of sales 600,000
Gross income P 400,000
Less: Operating expenses
Administrative expenses P 100,000
Selling expenses 120,000 220,000
Net income P 180,000

Requirements:
1. How much is the OSD of the taxpayer?
2. How much is the net income under the OSD?
Illustration 1 – Solution
1. OSD of the taxpayer
If the taxpayer is
Individual Corporation
Sales, net of returns, allowances, and discounts P1,000,000 P1,000,000
Less: Cost of sales - 600,000
Gross income P1,000,000 P 400,000
Multiply by: OSD rate 40% 40%
Optional Standard Deductions P 400,000 P 160,000

2. Net income under the OSD

Individual Corporation
Sales, net of returns, allowances, and discounts P1,000,000 P1,000,000
Less: Cost of sales - 600,000
Gross sales/income P1,000,000 P 400,000
Less: Optional Standard Deductions 400,000 160,000
Net Income P 600,000 P 240,000
The Individual OSD
 The OSD of individuals is based on gross receipts or gross sales, it is deemed to replace
all items of deductions against gross receipts or gross sales in computing net income.
 Individuals using OSD shall use BIR Form 1701A in filing their annual return.
https://www.bir.gov.ph/images/bir_files/taxpayers_service_programs_and_monitoring_1/1701
A%20Jan%202018%20v5%20with%20rates.pdf

The Corporate OSD

 The corporate OSD is based on gross income, it is deemed to replace all items of
deductions from gross income.
 Corporations opting to use OSD shall use BIR Form 1702-RT for their annual income tax
return.
https://www.bir.gov.ph/images/bir_files/taxpayers_service_programs_and_monitoring_1/1702-
RT%20Jan%202018%20ENCS%20Final%20v3.pdf
RULES ON DETERMINATION OF OSD FOR INDIVIDUAL TAXPAYERS
Gross Sales
 As clarified by RR16-2008r gross sales include only sales contributory to income subject
to regular tax. Since sales returns, allowances and discounts are not contributory to
income, they must be deducted from the total recorded sales.

Gross Receipts
 This means amounts actually or constructively received during the taxable year. For
sellers of services employing the accrual basis of accounting, the term “gross receipts”
shall mean amounts earned as gross revenue during the taxable year.
 For individual taxpayers using other methods of accounting, the gross sales or gross
receipts shall be determined in accordance with said acceptable method of accounting.
 The optional standard deduction for individual taxpayers is especially computed as:
Net sales/revenues/receipts/fees P xxx,xxx
Add: Other taxable income from operation not subject to final tax xxx,xxx
Total sales/revenues/receipts/fees P xxx,xxx
Multiply by: OSD percentage 40%
Optional Standard Deduction P xxx,xxx

Other taxable income from operations not subject to final tax

 This includes those revenues or receipts arising from incidental or secondary activities of
business or profession but does not include items that are net of costs such as gains.
Non-operating income
1. Gains from dealings in properties
2. Distribution from a general professional partnership, exempt co-ownership and taxable
estates or trusts
3. Casual active income
4. Passive income or those not connected to the primary or secondary activities of the
business such as:
a. interest income on advances to employees
b. investment income subject to regular tax
Illustration 2
Mr. Lagawe, a manufacturer of goods under the accrual basis, opted to claim optional standard
deduction. Aside from manufacturing, Mr. Lagawe also leases a portion of his building to other
businesses. The following relate to his income:
Gross recorded sales P4,000,000
Sales returns, allowances, and discounts 200,000
Rental income 300,000
Interest income from bond investment 15,000
Interest income from customers’ notes 100,000
Gain on sale of equipment 20,000
Dividend from domestic corporation 18,000

Requirements:
1. How much is the OSD of the taxpayer?
2. How much is the net income under the OSD to be presented in the income tax
return?
Illustration 2 - Solution
1. OSD of the taxpayer
Gross recorded sales (P4,000,000 – P200,000) P 3,800,000
Add: Other taxable income from operations not subject to final tax
Rental income 300,000
Interest income from customers’ notes 100,000 400,000
Total sales/revenues/receipts/fees P 4,200,000
Multiply by OSD rate 40%
Optional Standard Deductions P 1,180,000
2. Net income under the OSD to be presented in the income tax return
Net sales/revenues/receipts/fees P 3,800,000
Add: Other taxable income from operations not subject to final tax
Rental income 300,000
Interest income from customers’ notes 100,000 400,000
Total sales/revenues/receipts/fees P 4,200,000
Less: Cost of sales or services -
Gross Income from Business/Profession P4,200,000
Add: Non-operating income
Interest income – bond investment 15,000
Gain on sale of equipment 20,000 35,000
Gross income P4,235,000
Less: Optional Standard Deductions 1,680,000
Net Income P2,555,000
RULES ON DETERMINATION OF OSD FOR CORPORATE TAXPAYERS
Gross Income
 Under the NIRC, gross income was restrictively defined as:
a. Gross sales less sales return, discounts and allowances and cost of sales; or
b. Gross receipts, less sales returns, discounts and allowances and cost of services
 However, under the amendments introduced by RA 9504, gross income for purposes of the
corporate OSD pertains to all gross income subject to the regular income tax.
 There is no distinction between gross income from operations and gross income from non-
operating sources. Thus, the OSD is computed as follows:
Net Sales/Revenues/Receipts/Fees P xxx,xxx
Less: Cost of sales or services xxx,xxx
Gross income from operations P xxx,xxx
Add: Other taxable income, not subject to final tax xxx,xxx
Total gross income P xxx,xxx
Multiply by: OSD percentage 40%
Optional standard deduction P xxx,xxx
Illustration 3 – Corporate Seller of Goods
Samar Corporation, a taxpayer under the accrual basis of accounting, opted to deduct OSD.
The following relates to its results of operations:
Gross sales, net of returns, allowances, and discounts P 3,850,000
Gain on sale of building 500,000
Dividend from domestic corporation 50,000
Beginning inventory P 300,000
Net purchases 3,000,000
Ending inventory 800,000
Recorded administrative and selling expenses P 760,000

Requirements:
1. How much is the cost of goods sold?
2. How much is the OSD of the taxpayer?
3. How much is the taxable net income?
Illustration 3 – Corporate Seller of Goods - Solution
1. The cost of goods sold
Beginning inventory P 300,000
Add: Net purchases 3,000,000
Total goods available for sale P 3,300,000
Less: Ending inventory 800,000
Cost of sales P 2,500,000

2. OSD of the taxpayer

Gross sales, net of returns, allowances, and discounts P 3,850,000
Less: Cost of sales 2,500,000
Gross income from operations P 1,350,000
Add: Other taxable income not subject to final tax
Gain on sale of building 500,000
Total gross income P 1,850,000
Multiply by: OSD rate 40%
Optional Standard Deduction P 740,000
2. The taxable net income
Net sales/revenues/receipts/fees P 3,850,000
Less: Cost of sales or services 2,500,000
Gross Income from operations P 1,350,000
Add: Other taxable income not subject to final tax
Gain on sale of building 500,000
Gross income P 1,850,000
Less: Optional Standard Deductions 740,000
Taxable Net Income P 1,110,000
What constitute cost of services?
Cost of services includes all direct costs and expenses necessary to provide the service
required by the customer such as:
a. Salaries and employee benefits of personnel, consultants and specialists directly
rendering the service
b. Cost of facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies.

The cost of services of banks includes interest expense.

Illustration 4
Leek Review Center Inc. provides preparatory review services for professional examinees.
Leek had the following expenses:
Salaries of reviewers P 800,000
Administrative staff salaries 80,000
Marketing salaries and other expenses 150,000
Rent expense on review rooms 300,000
Rent on administrative offices 100,000
Printing costs of reviewee handouts 100,000
Classroom & library electricity expense 30,000
Office utilities 40,000
Classroom supplies expense 5,000
Loss on sale of old chairs 15,000
Interest expense 50,000
tax following shall be the direct Cost of services:
Waries of rewiewers P 800,000 >atexpense on review rooms 300.000 Mating costs of reviewee
handouts 100,000 &ssroom & library electricity expense 30,000 gclude accrued income.
Similarly. supplies expense
Illustration 4
Leek Review Center Inc. provides preparatory review services for professional examinees.
Leek had the following expenses:
Salaries of reviewers P 800,000
Administrative staff salaries 80,000
Marketing salaries and other expenses 150,000
Rent expense on review rooms 300,000
Rent on administrative offices 100,000
Printing costs of reviewee handouts 100,000
Classroom & library electricity expense 30,000
Office utilities 40,000
Classroom supplies expense 5,000
Loss on sale of old chairs 15,000
Interest expense 50,000

Requirement: Identify the direct cost of services.

Illustration 4 - Solution
The following are the direct cost of services:
Salaries of reviewers P 800,000
Rent expense on review rooms 300,000
Printing costs of reviewee handouts 100,000
Classroom & library electricity expense 30,000
Classroom supplies expense 5,000
Cost of services P 1,235,000
OSD FOR GENERAL PROFESSIONAL PARTNERSHIPS
Determination of net income of a GPP
 For purposes of computing the distributive share of the partners, the net income of the
partnership shall be computed in the same manner as a corporation. (Sec. 26, NIRC)
 A GPP can choose either the itemized deduction or the optional standard deduction in
computing its distributable net income.
 The allowable deduction for GPP electing to deduct OSD shall be 40% of gross income
similar to the OSD allowed for corporations.
OSD FOR GENERAL PROFESSIONAL PARTNERSHIPS
Deductions against partner’s share in net income from GPP
The TRAIN law provides that either the GPP or the partner may avail of OSD.
However, the TRAIN law retained the old rule which based individual OSD on gross
receipts or gross sales and did not adopt the proposal to revert it back on gross income.
This rendered the OSD option of GPP partners under the TRAIN law purely academic.
Thus, partners in GPP cannot claim OSD against their share in net income. The share in
the net income of the GPP is not gross receipt but a gross income. Gross receipt refers to
collection from rendering of services.
It must be clarified however that partners may use OSD against their gross sales or
receipts from business or profession. They are only precluded from claiming OSD against
their share in net income of the GPP.
No more allowed deduction against share in the net income of GPP
Before the TRAIN law revision, a partner can claim itemized deductions from his share in
the net income of a GPP, provided that the GPP also uses itemized deductions in computing
its distributive net income and not OSB. Under RR8-2018, a partner can no longer claim
deductions from their share in GPP net income.

Share in the net income vs. Actual profit distribution

 The share in the net income is computed from the net income of the determined by tax
rules.
 The actual profit distribution is computed from net income as determined by generally
accepted accounting rules. It is the actual amount of profit that will be transferred to the
capital of each partner.
 These two normally differ because of the following:
a. Deductibility limits or requirements on some items of deductions
b. Use of OSD by the general professional partnership
Deduction limits, deductibility requirements, and OSD
Any tax rule which will allow deductions at an amount different from the actual expense will
make the taxable net income different from the accounting net income. For instance, an
expense that is allowed only as a deduction in part or is disallowed in totality will result in
higher tax net income over accounting net income.
It must be noted that the amount to be included in the gross income of the is the share in
net income for purposes of the regular tax and not the actual profit distribution.
Illustration 5
Atty. Bernard is a partner in BCBC Company, a general professional partnership, owning ¼ of
the firm. Atty. Bernard also derives separate professional income from his accounting
profession.
The following data pertain to the GPP and income and expenses of Atty. Bernard during a
year:
GPP Bernard
Professional fees P 4,000,000 P 500,000
Interest on bank deposits 32,000 8,000
Direct cost of services 1,900,000 120,000
Other deductible expenses 700,000 240,000

The following expenses were incurred by Bernard for the general professional partnership but
were not reimbursed by the firm:
a. P20,000 receipted in the name of the partnership but was not reimbursed for lack of
secondary approval
b. P15,000 receipted in the name of Bernard, not in the name of the firm
Requirements:
Case A : The GPP uses itemized deduction.
1. How much is the GPP’s distributable net income?
2. If Bernard uses itemized deductions, how much is his taxable income?
3. If Bernard uses OSD, how much is his taxable income?

Case B : The GPP uses OSD.

1. How much is the GPP’s distributable net income?
2. If Bernard uses itemized deductions, how much is his taxable income?
3. If Bernard uses OSD, how much is his taxable income?
Illustration 5 - Solutions
Case A : The GPP uses itemized deduction.
1. GPP’s distributable net income
Net sales/revenues/receipt/fees P 4,000,000
Less: Direct cost of services 1,900,000
Gross income from operations P 2,100,000
Add: Interest on bank deposits 32,000
Total gross income P 2,132,000
Less: Regular allowable itemized deductions 700,000
Distributable net income P 1,432,000

Share of Atty. Bernard in the net income of the GPP:

Distributable net income P 1,432,000
Ownership of Atty. Bernard ¼
Atty. Bernard’s share P 358,000
2. Taxable income of Atty. Bernard if he uses itemized deductions
Net sales/revenues/receipt/fees P 500,000
Add: Other taxable income from operations -
Total sales/revenues/receipt/fees P 500,000
Less: Cost of services 120,000
Gross income from business/profession P 380,000
Add: Non-operating income
Share in net income of GPP 358,000
Total Gross Income P 738,000
Less: Allowable deductions
Other deductible expense P240,000
Unreimbursed GPP expense 0 240,000
Taxable net income P 498,000
3. Taxable income of Atty. Bernard if he uses OSD
Net sales/revenues/receipt/fees P 500,000
Add: Other taxable income from operations -
Total sales/revenues/receipt/fees P 500,000
Less: Cost of services -
Gross income from business/profession P 500,000
Add: Non-operating income
Share in net income of GPP 358,000
Total Gross Income P 858,000
Less: Optional Standard Deductions (40% x P500,000) 200,000
Taxable net income P 658,000
Case B : The GPP uses optional standard deduction.
1. GPP’s distributable net income
Net sales/revenues/receipt/fees P 4,000,000
Less: Direct cost of services 1,900,000
Gross income from operations P 2,100,000
Add: Interest on bank deposits 32,000
Total gross income P 2,132,000
Less: Optional standard deductions (P2,132,000 x 40%) 852,800
Distributable net income P 1,279,200

*Distributable net income is different with the actual accounting net income (P1,432,000).

Share of Atty. Bernard in the net income of the GPP:

Distributable net income P 1,279,200
Ownership of Atty. Bernard ¼
Atty. Bernard’s share P 319,800
2. Taxable income of Atty. Bernard if he uses itemized deductions
Net sales/revenues/receipt/fees P 500,000
Add: Other taxable income from operations -
Total sales/revenues/receipt/fees P 500,000
Less: Cost of services 120,000
Gross income from business/profession P 380,000
Add: Non-operating income
Share in net income of GPP 319,800
Total Gross Income P 699,800
Less: Allowable deductions
Other deductible expense P240,000
Unreimbursed GPP expense 0 240,000
Taxable net income P 459,800
3. Taxable income of Atty. Bernard if he uses OSD
Net sales/revenues/receipt/fees P 500,000
Add: Other taxable income from operations -
Total sales/revenues/receipt/fees P 500,000
Less: Cost of services -
Gross income from business/profession P 500,000
Add: Non-operating income
Share in net income of GPP 319,800
Total Gross Income P 819,800
Less: Optional Standard Deductions (40% x P500,000) 200,000
Taxable net income P 619,800
Optional Standard Deduction and NOLCO
 NOLCO cannot be claimed simultaneously with OSD because NOLCO is an item of
deduction while OSD is a proxy for all itemized deductions.
 NOLCO is deemed in the claimable OSD.

Optional Standard Deduction and Net Capital Loss Carry Over

 OSD does not replace net capital loss carry-over of individual taxpayers.
 The net capital loss carry-over is used in the measurement of net capital gain which is an
of gross income. In other words, it is not an item of deduction.
 Hence, a net loss carry-over from the prior year can still be deducted against the net
capital gain of the current year even if the taxpayer opted to deduct optional standard
deduction for the current year.
WHEN TO INDICATE THE OPTION TO USE OSD?
 For individual taxpayers, the option to use OSD can be indicated only in the annual
income tax return since quarterly income tax returns are mere estimates of gross income
and deductions.
 For corporate taxpayers, the option to use OSD for the taxable year must be indicated in
the first quarter return and shall be applied to all subsequent quarters and in the annual
return. The option to use either itemized deduction or OSD is irrevocable only for the
current year it is made.
Questions to Ponder
1. What is optional standard deduction?
2. Who can claim OSD? Who cannot claim OSD?
3. Explain the distinction between an operating income and a non-operating income.
4. Discuss the OSD base for an individual taxpayer and the OSD base for a corporate
taxpayer.
5. Discuss the rules of OSD for a general professional partnership and the partners.
Required Readings
Chapters 13C, pp. 553 – 569:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay,
Pasay City, Philippines.

Income Tax Return

https://www.bir.gov.ph/index.php/bir-forms/income-tax-return.html
Learning Activities
Chapters 13C, pp. 570 – 578:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay,
Pasay City, Philippines.
References
Chapters 13C, pp. 553 – 569:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay,
Pasay City, Philippines.
 Appendix: Course Materials Evaluation
Adopted: BEST PRACTICES AND SAMPLE QUESTIONS FOR COURSE EVALUATION SURVEYS. Retrieved from
https://assessment.provost.wisc.edu/best-practices-and-sample-questions-for-courseevaluation-surveys//.