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Itemized or standard deductions?

Itemized or standard deductions?

by Senen M. Quizon

In claiming a tax deduction for an expense, a taxpayer must not only establish the relation of the expense to the conduct of his/her business or practice of profession, but also substantiate the expense.   Individual Corporation

You can support your expenses by keeping adequate records and presenting documentary evidence, like invoices and official receipts, to establish that your expenses were used for business rather than personal purpose.

Otherwise, the tax deduction may be disallowed and you may be assessed additional taxes and penalties.

To minimize this struggle in record-keeping and accounting for deductions, taxpayers may choose to avail of the optional standard deduction (OSD).

Additionally, because of the increase in the OSD rates from 10%-40%, as provided for under Republic Act (RA) 9504, switching to OSD would necessarily mean an opportunity to claim bigger deductions and reduce ones income tax liability.

One of the basic rules in choosing between itemized deduction and OSD is to determine which of the two will allow you to claim higher deductions.

However, in rare occasions wherein your itemized deductions and OSD approximately equal each other, availing of the OSD is the more practical choice if you want to avoid disputes and unnecessary stress from Bureau of Internal Revenue (BIR) examination.

The option to elect OSD is granted to individual taxpayers (self-employed and professionals) and just recently, to corporations (domestic and resident foreign corporations) by virtue of RA 9504 — the same law that increased the OSD rates of individuals.

It is interesting to note, however, that while both individuals and corporations are entitled to 40% OSD, they have differing OSD bases, i.e., gross income for corporations and gross sales/receipts for individuals.

Owing to the difference in their OSD base, the 40% OSD for individuals and corporations shall be treated differently, as gathered from the public pronouncements of the BIR on RA 9504.

According to the BIR, the 40% OSD for individuals, in effect, shall replace not only the itemized deductions/operating expenses but also cost of goods sold/cost of sales. This means that the 40% OSD for individuals shall be deducted from their gross sales/receipts to arrive at their net taxable income.

This is in contrast to the previous system wherein the 10% OSD for individuals is deducted from the gross income (i.e., gross sales/receipt less cost of goods sold/cost of sales).

The following table illustrates the differences in how the BIR plans to implement the OSD for individuals and corporations:

 Individual      Corporation   
Gross Sales/Receipts          

P1,000,000

P1,000,000

Less: Cost of Goods Sold/Cost of Service

600,000

600,000

Gross Income

1,000,000

400,000

Less:  OSD   
Individual (40% X P1M)

400,000

 
Corporation (40% X P400,000 

160,000

N et Income

600,000

240,000

The difference on the basis of computing OSD fo r individuals and corporations is certainly one of the issues that the BIR has to resolve carefully so as not to appear to be favoring corporations where the OSD is deducted on top of the cost of goods sold/cost of sales.

Another issue that the implementing rules will have to contend with is the effectivity of the OSD.

Following the manner in which the BIR implemented the exemption of minimum wage earners and increase in exemption allowances, it is likely that an individual electing OSD will only be allowed to apply the 10% rate on gross income for the period covering January 2008 to July 5, 2008 before the effectivity of RA 9504.

The 40% OSD on gros s sales/receipts may be applicable only for the period covering July 6, 2008 to December 31, 2008.

In the case of a corporation, it is likely that it will only be allowed to use the 40% OSD beginning July 6, 2008. Thus, for the period January 1 to July 5, 2008, the method of deduction to be used by corporate taxpayers availing of OSD for taxable year 2008 shall remain under the itemized deduction method.

Once the option to use OSD is made as signified in the return, RA 9504 provides that it shall be irrevocable for the taxable year for which the return is made.

Based on public pronouncements of the BIR, this means that a taxpayer who initially files a return availing of OSD is prevented from amending his/her return just to switch to itemized deductions or vice versa.

In deciding between OSD and itemized deductions, therefore, one should ascertain beforehand which of the two types of deductions will be more advantageous.

For additional information on OSD, we invite you to attend the P&A Tax Seminar-Year-end adjustments and updates ("Withholding on compensation, the corporate income tax and the OSD") this November 26 at the Renaissance Makati City Hotel.

For details, interested readers may contact Marge Antonio at 886-5511 local 519, or visit our Web site http://www.punongbayan-araullo.com.


(The author is a tax manager at Punongbayan & Araullo, a member firm within Grant Thornton International Ltd. For comments and inquiries, please e-mail Senen.Quizon@pna.ph or call 886-5511.)