From an employee to a self-employed

After many years of perseverance to finish college, pass the board examination and pursue the career of choice, most young professionals end up as employees in a company. Being an employee is the most common path of practicing one’s profession and earning money to satisfy one’s basic needs. As an employee, though, you are required to report to office usually at eight in the morning and you’re very lucky if you could leave the office at exactly five in the afternoon. You take directions from your boss and you get a fixed salary.

  

More often than not, at some point, it will come to one’s mind: “Why not be your own boss at the same time practice your profession or start a business?” Why not be a consultant instead of an employee in the company?

For many, being a sole practitioner/proprietor is equated to a bigger pay check and being able to set own working hours and schedules as well as conduct every phase of the business as deemed appropriate. Most employees also envy the privilege of individuals in business to deduct expenses 

for income tax purposes and, therefore, be subject to a lower tax. An employee is only entitled to the personal exemption of P50,000 and an additional exemption of P25,000 for every qualified dependent, if any.

But is a shift from an employee to a sole practitioner/proprietor as easy as 1-2-3?

As an employee, your life is quite simpler. The employer takes charge of updating your BIR registration as a new employee or for other updates. The employer is also responsible to withhold tax on salary and remit the same to the BIR. In most cases, employees are qualified for substituted filing, hence are no longer required to file an annual income tax return.

On the other hand, to operate a professional business as a sole practitioner, individuals must initially secure the business licenses, permits or certificates with certain agencies. To register with the BIR, the professional must first enlist the business name with the Department of Trade and Industry (DTI), and with the local government unit where the business is located, file an update of registration with the BIR from an employee to a sole practitioner/proprietor. The BIR will then issue a Certificate of Registration indicating the type of taxes to file and pay (e.g. income tax, percentage tax or value-added tax, etc.).

Thereafter, as a sole practitioner, one will also be required to issue an official receipt and maintain records to support expenses and input VAT. Books of accounts are needed, and an independent CPA may even be required to examine and audit books of accounts if the quarterly receipts exceed P150,000. One might be also be held liable as a withholding agent on the income payments made.

There are monthly and quarterly returns that have to be filed in addition to the annual tax returns with the BIR.

As a sole practitioner, the person will be liable to income tax at the same graduated rates of 5-32% on the taxable income. Taxable income shall be the excess of gross receipts over the cost incurred in rendering service and other related general and administrative expenses. In lieu of the itemized deductions, the taxpayer can avail of an optional standard deduction of 40% of gross receipts to arrive at taxable income. 

It should be noted that professional fees are subject to the expanded withholding tax of 10% (15% if the annual gross receipt of the professional exceeds P720,000). The tax withheld, as evidenced by the certificate of creditable income tax withheld (BIR Form 2307) shall be used as a deduction on the income tax due of the professional.

In addition to income tax, a professional shall pay 3% percentage tax on gross receipts or 12% VAT if the annual gross receipts exceed P1,919,500 or if the professional opted for VAT registration.

One is also required to annually renew the registration with the BIR and pay the corresponding local business tax with the local government unit.

These compliance requirements are bound by interest, surcharges and penalties for every failure, omission or late compliance, notwithstanding how good or bad your business is doing Entrepreneurial initiatives are always encouraged. However, an entrepreneur should be well aware of his responsibilities especially to the regulatory agencies which are not as simple as those of an employee.

It is worth mentioning that the Commissioner of Internal Revenue has mentioned on several interviews that the BIR will be giving “special attention” to professionals. These are the compromises in exchange for the upsides associated with this career path.