Module 7 - Introduction to Regular Income Tax PDF

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INTRODUCTION TOREGULAR INCOME TAXModule No. 7BAINCTAXIncome TaxationLEARNING OUTCOMESAt the end of this module, you are expected to: Describe the characteristics of regular income tax; Illustrate the regular income tax model and its components; Identify the relevant returns for regular income tax; D...

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INTRODUCTION TO REGULAR INCOME TAX Module No. 7

BAINCTAX Income Taxation LEARNING OUTCOMES

TOPICS INCLUDED

At the end of this module, you are expected to: 1. Describe the characteristics of regular income tax; 2. Illustrate the regular income tax model and its components; 3. Identify the relevant returns for regular income tax; 4. Differentiate computation of taxable income for special taxpayers; 5. Explain the effects of choosing the 8% income tax; 6. Compute the income tax due; 7. Explain the globalization rule for mixed income earners; 8. Apply the rules on rounding in accomplishing returns; and 9. Identify the required attachments for each return.

Included in this module are the following: 1. Characteristics of Regular Income Tax 2. Regular Income Tax Model 3. Regular Income Tax Returns 4. 8% Optional Income Tax 5. Special Taxpayers 6. Globalization Rule 7. Rounding Rules 8. Required Attachments

1 Pre-Activity Try to answer the following questions. 1. What is usually needed for reference in a progressive tax? 2. Do you think income from illegal activities, in theory, should be taxed? 3. How do you think is the income tax due computed? 4. What are the differences of a traditional Income Statement to that of the Income Tax Return? 5. Do you think the rules on rounding off from your basic Mathematics classes apply in tax reporting? 6. Which would you prefer between ease in tax computations or lower income tax due?

REGULAR INCOME TAX As discussed in the previous modules, the income tax scheme of regular income taxation is a catch basin for all those items of income which are not specifically within the scopes of final income taxation and capital gains taxation.

CHARACTERISTICS The following are the characteristics of this income tax scheme.

General Coverage The regular income tax applies to all items of income except those that are subject to final tax, capital gains tax, and special tax regimes.

Net Income taxation The regular tax is an imposition on residual profits or gains after deductions for expenses and personal exemptions allowable by law.

Annual Income Tax The regular income tax applies on yearly profits or gains. The gross income and expenses of the taxpayer are measured using the accounting methods adopted by the taxpayer and are reported to the government over the accounting period selected by the taxpayer.

Creditable Withholding Taxes Most items of regular income are subject to creditable withholding tax (CWT). These creditable withholding taxes are advanced taxes that must be deducted against regular tax due in computing the tax still due to the government.

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Progressive or Proportional Tax The NIRC imposes a progressive tax on the taxable income of individuals while it imposes a flat or proportional tax of 30% upon the taxable income of corporations. Note that the revision of the corporate income tax in the second package of the TRAIN Law proposes a 25% corporate income tax.

REGULAR INCOME TAX MODEL The formula below illustrates the bird’s eye view of the regular income tax scheme. Gross Income Allowable Deductions

xx (xx)

Taxable Income

xx

Tax Due

xx

Tax Credits Tax Payable/(Overpayment)

(xx) xx

It is to be noted that extensive discussions of each item in the model will be included in the succeeding modules.

Gross Income The gross income consists of all other items of income not taxed under the Final Taxation and Capital Gains Taxation and other special tax regimes. Some items of income, however, are excluded or exempted by law, treaty or contract from taxation. Normal items of gross income are as follows: 1.

Compensation Income

2.

Business/Professional Income

3.

Capital Gains

Excluded Income vs. Exempt Income vs. Deductions Excluded income is also exempt income. Excluded income are those listed by the NIRC as exempt from regular tax. The term exempt income includes all income exempt from income tax whether final tax, capital gains tax or regular income tax. Exclusions from gross income are listed in the NIRC. Both excluded and exempt income are not included in the amount of reportable gross income in the income tax return. The amount of deductions is initially included in the amount of gross income but is separately presented as deduction against gross income.

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Allowable Deductions Allowable deductions, or simply “deductions,” are expenses in the conduct of business or exercise of profession. It should be noted that only business expenses are allowed for deductions, considering limits and caps given by law.

Taxable Income This is the basis of the income tax due.

Tax Due The progressive tax table below shall be used for individual taxpayers and the 30% income tax rate for corporate taxpayers. In computing the tax due for individuals, the taxable income is located on the applicable bracket of the income tax table to know the basic tax and the additional tax rate. Taxable Income

Basic Tax

Additional Tax

250,000

-

-

250,000

400,000

-

20% of excess over 250,000

400,000

800,000

30,000

25% of excess over 400,000

800,000

2,000,000

130,000

30% of excess over 800,000

2,000,000

8,000,000

490,000

32% of excess over 2,000,000

8,000,000

-

2,410,000

35% of excess over 8,000,000

Over

But Not Over

0

Tax Credits Tax credits are subtracted not from taxable income, but directly from a person’s tax liability; they therefore reduce taxes peso for peso. As a result, credits have the same value for everyone who can claim their full value. As one of the characteristics of regular taxation, it is subject to creditable withholding taxes. As such, any withheld taxes from payors of income may be used as tax credits to be deducted to the Tax Due. Tax credits usually arise from creditable withholding taxes.

Tax Payable/(Overpayment) This is the net amount of the tax liability to the BIR. If the tax credits exceed the tax due, the overpayment may be refunded or used as tax credits in the succeeding periods.

INTRODUCTION TO REGULAR INCOME TAX | Module No. 7

4 Illustration 7.1 Tim Maray has a total income of P1,240,000 during the taxable year. Of the said amount, P110,000 were subject to final tax and P80,000 were subject to capital gains tax. Of the remaining amount, P50,000 are considered exempt. He also incurred P520,000 worth of expenses but P40,000 was not allowed for deduction. Several of the income were subjected to creditable withholding taxes which reduced the receipts of income to P1,229,000. Following the regular income tax model, the taxable income would be: Gross Income (1,240,000 – 110,000 – 80,000 – 50,000)

1,000,000

Less: Allowable Deductions (520,000 – 40,000)

480,000

Taxable Income

520,000

Scenario 1: Tim Maray is an individual The tax payable, basing on the third bracket of the progressive tax table, would be: Basic Tax

30,000

Additional Tax (25% x 120,000)

30,000

Tax Due

60,000

Less: Tax Credits (1,240,000 – 1,229,000)

11,000

Tax Payable

49,000

Scenario 1: Tim Maray is a corporation The tax payable would be: Taxable Income

520,000

Tax Rate

30%

Tax Due

156,000

Less: Tax Credits

11,000

Tax Payable

145,000

REGULAR INCOME TAX RETURNS The following are the required returns for taxpayers. [You may click the form codes for links on the full pdf of the return.] Form Code 1700 1701A 1701

Type of Taxpayer Purely Employed Individuals Individuals purely in Business, using Itemized Deduction, OSD or opting to the 8% Optional Income Tax Mixed Income Earning Individuals, Estates and Trusts

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5 1702RT

Corporations subject only to the 30% Regular Income Tax

1702MX

Corporations subject to Special or a combination of tax rates

1702EX

Corporations that are exempt with no tax due

It should be noted that exempt corporations are required to report their results of operations through BIR Form 1702-EX even if they do not have taxable income. They are mandated to itemize their deductions in their income tax return. The rule is apparently intended to assist the BIR in monitoring compliance of exempt corporation with their withholding tax obligations and to provide for a mechanism to identify income earned by third parties. Exempt corporations with gross income subject to the regular corporate income tax or special rate shall file BIR Form 1702-MX.

Individual ITR Line Items Let us take a look at Form 1701 to further evaluate the regular income tax model for individuals. You are encouraged to familiarize yourself with the structure of the income tax return to facilitate understanding in the succeeding modules.

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The taxable compensation income only comprises of the Taxable Compensation Income

gross compensation income and the exempt portion. These two are netted. Information on this portion normally comes from the accomplished BIR Form 2316 by the employer which will be further discussed in Module 10.

Gross Income/(Loss) from Operation Allowable Deductions Net Income/(Loss) from Operations Other Non-Operating Income

This portion follows that of the traditional format of the Gross Profit computation in the Income Statement. There are different types of deductions which the taxpayer can avail. This is the difference of the gross income from operations and allowable deductions. These are separated since some rules (e.g. OSD) are not applicable to revenues from non-business endeavors.

Taxable Business Income Total Taxable Income

This is the sum of all taxable non-compensation income. This will now be the basis of the income tax due of the individual taxpayer.

Tax Payable/(Overpayment)

This is similar to the tax model. Tax credits will be extensively discussed in Module 16.

Looking at the structure of the items in the form, it can be presented in the form below to illustrate it in practical sense. Taxable Compensation Income Gross Compensation Income Exempt/Non-Taxable Compensation Income

xx (xx)

xx

Taxable Business Income Net Sales/Revenues/Receipts/Fees Cost of Sales/Services Gross Income/(Loss) from Operations Allowable Deductions

xx (xx) xx (xx)

Net Income/(Loss) from Operations

xx

Other Non-Operating Income

xx

Total Taxable Income

INTRODUCTION TO REGULAR INCOME TAX | Module No. 7

xx xx

7 Tax Due

xx

Tax Credits

(xx)

Tax Payable/(Overpayment)

xx

For purely self-employed individuals, the portion for compensation income is ignored. Same is true for purely employed individuals on the portion for business income. Illustration 7.2 Chutimon, an individual taxpayer, reported the following for the taxable year. 

Gross compensation of P140,000, P20,000 of which was exempt.



Winnings from PCSO Lotto, P60,000.



Capital gain of jewelries sold, P50,000.



Gross income from merchandising business, P470,000.



Expenses of the merchandising business, P210,000, P25,000 of which are nondeductible.



Prior year’s excess credits, P10,000.

The tax payable would be computed as follows: Taxable Compensation Income Gross Compensation Income Exempt/Non-Taxable Compensation Income

140,000 20,000

120,000

Taxable Business Income Gross Income/(Loss) from Operations

470,000

Allowable Deductions

185.000

Net Income/(Loss) from Operations

285,000

Other Non-Operating Income

50,000

Total Taxable Income

335,000 455,000

Tax Due

43,750

Tax Credits

10,000

Tax Payable/(Overpayment)

33,750

Quarterly Return Let us take a look at the 1701Q to differentiate it with the annual ITR.

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The quarterly return is mostly similar to that of the annual return. The difference is that the amounts for the computation of the net income/(loss) from operations only include those arising from the period the return covers. The quarterly return is cumulative in amount. This means that it computes the income tax due based on the cumulative taxable income as of the close of the taxable quarter. This is why it adds the reported taxable income from the previous quarterly returns filed during the year. Also take note that only the business income is included in the quarterly returns. The taxable compensation income is only reported in the annual income tax return.

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9 Illustration 7.3 Pat, a mixed income earner, reports the following for each quarter of 2020. Item First Second Third Taxable Compensation

Fourth

90,000

90,000

90,000

90,000

240,000

160,000

180,000

380,000

Allowable Deductions

90,000

80,000

80,000

120,000

Non-Operating Income

10,000

15,000

40,000

10,000

Gross Income from Business

The only sources of tax credit are the timely tax payments made every quarter and the income tax withheld from compensation amounting to P22,000. The income tax returns to be filed would carry the following amounts: Item Q1 Q2 Gross Income from Business

Q3

Annual

240,000

160,000

180,000

960,000

90,000

80,000

80,000

370,000

150,000

80,000

100,000

590,000

-

160,000

255,000

-

10,000

15,000

40,000

75,000

160,000

255,000

395,000

665,000

-

-

-

360,000

160,000

255,000

395,000

1,025,000

Tax Due

-

1,000

29,000

197,500

Tax Credits

-

-

1,000

51,000

Tax Payable

-

1,000

28,000

146,500

Allowable Deductions Net Income from Operations Taxable Income from Previous Quarter/s Non-Operating Income Total Taxable Business Income to Date Taxable Compensation Income Total Taxable Income

Corporate ITR Line Items Let us also take a look on a portion of the 1702RT to illustrate the same for corporate taxpayers.

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Gross Income from Operation

This is mostly similar with that of individuals. Other taxable income not subjected to final tax is directly

Other Taxable Income

added to the gross income from operations, not unlike for individuals where it is only added after the allowable deductions are deducted.

Total Taxable Income

This is the total gross taxable income.

INTRODUCTION TO REGULAR INCOME TAX | Module No. 7

11 Allowable Deductions

Similar to that of individuals, it is to be further discussed in Modules 13-15.

Net Taxable Income/(Loss)

This is the basis of the income tax due.

Tax Payable/(Overpayment)

This is similar to that of individuals.

Looking at the structure of the items in the form, it can be presented in the form below to illustrate it in practical sense. Net Sales/Receipts/Revenues/Fees Cost of Sales/Services

xx (xx)

Gross Income from Operation

xx

Other Taxable Income Not Subjected to Final Tax

xx

Total Taxable Income

xx

Allowable Deductions

(xx)

Net Taxable Income/(Loss)

xx

Tax Due

xx

Tax Credits Tax Payable/(Overpayment)

(xx) xx

Illustration 7.4 Assume Chutimon from Illustration 7.2 is a corporate taxpayer and ignore the figures related to the compensation income. The tax payable would be computed as follows: Gross Income from Operation

470,000

Other Taxable Income Not Subjected to Final Tax

110,000

Total Taxable Income

580,000

Allowable Deductions

185,000

Net Taxable Income/(Loss)

395,000

Regular Corporate Tax Rate

30%

Tax Due Tax Credits Tax Payable/(Overpayment)

INTRODUCTION TO REGULAR INCOME TAX | Module No. 7

118,500 10,000 108,500

12 Quarterly Return The difference of the quarterly and annual ITR for corporations is similar to that of individuals, except that there is no compensation income.

8% OPTIONAL TAX Individual taxpayers have the option of availing the 8% optional tax as provided by RA 10963. It should be noted that the taxpayer should signify that it chooses this option on the first quarterly income tax return and/or quarterly percentage tax return for every year. Such election shall be irrevocable and no amendment of option shall be made for the said taxable year. Purely Self-Employed Individuals The taxpayer may opt to be taxed under the two schemes, provided that his gross sales/receipts and other non-operating income do not exceed the P3,000,000 VAT threshold: 1. 8% of gross sales/receipts and other non-operating income in excess of P250,000 in lieu of graduated rates and percentage tax; or 2. Graduated rates Below is the portion of 1701A that should be filled out.

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Mixed-Income Earners If the individual taxpayer earns compensation income aside from its exercise of profession, trade or business, he shall have no choice but to be taxed at the graduated rates on its compensation income. Its business income, however, may be opt to be taxes at the following schemes, provided that his gross sales/receipts and other non-operating income do not exceed the P3,000,000 VAT threshold: 1. 8% of gross sales/receipts and other non-operating income in lieu of graduated rates and percentage tax; or 2. Graduated rates It should be noted that the P250,000 exemption is not deducted on...