MODULE 5: Individual Income Taxation

1. Regular / Ordinary Normal Income Tax: A. Types of Individual Income Taxes

A. Types of Individual Income Taxes

Individual taxpayers may be subject to five main types of income taxes:

Type of Tax	Explanation
Regular Graduated Income Tax	Tax imposed on net taxable income using progressive rates from 0% to 35%.
Optional 8% Income Tax	Alternative tax available to qualified self-employed and mixed-income earners.
Final Tax on Passive Income	Tax withheld at source on certain passive income, such as bank interest, royalties, and dividends.
Capital Gains Tax (CGT)	Tax imposed on certain gains or presumed gains from the sale of capital assets.
Fringe Benefits Tax (FBT)	Final tax imposed on the grossed-up value of fringe benefits given to managerial and supervisory employees.

1. Regular / Ordinary Normal Income Tax: Classification of Individual Income Earners

B. Classification of Individual Income Earners

Before computing income tax, identify the taxpayer's classification because this determines which income is included and how the tax is computed.

Classification	Meaning	Example
Compensation Income Earner	Earns income solely from an employer-employee relationship.	An employee receiving a monthly salary.
Self-Employed Individual	Earns income from business or the practice of a profession without an employer-employee relationship.	A freelance accountant or business owner.
Mixed-Income Earner	Earns both compensation income and income from business or professional activities.	An employee who also operates a small business.

1. Regular / Ordinary Normal Income Tax: C. Regular Graduated Income Tax Rates

C. Regular Graduated Income Tax Rates

The regular graduated income tax applies progressive rates to an individual's net taxable income. This means that the tax rate increases as taxable income increases.

The rates below are effective January 1, 2023.

Net Taxable Income	Income Tax Due
Not over ₱250,000	0%
Over ₱250,000 but not over ₱400,000	15% of excess over ₱250,000
Over ₱400,000 but not over ₱800,000	₱22,500 + 20% of excess over ₱400,000
Over ₱800,000 but not over ₱2,000,000	₱102,500 + 25% of excess over ₱800,000
Over ₱2,000,000 but not over ₱8,000,000	₱402,500 + 30% of excess over ₱2,000,000
Over ₱8,000,000	₱2,202,500 + 35% of excess over ₱8,000,000

How to understand the progressive tax system:

The taxpayer does not pay the highest percentage on their entire income. Instead, the applicable rate is determined by the tax bracket in which their taxable income falls, using the corresponding base tax plus the percentage of the excess.

For example, if taxable income is ₱900,000:

\[ ₱102,500 + 25\%(₱900,000-₱800,000) \]

=₱102,500+₱25,000=₱127,500

1. Regular / Ordinary Normal Income Tax: D. Tax Base and Allowable Deductions

D. Tax Base and Allowable Deductions

Under the regular graduated income tax system, the tax is computed using net taxable income, not simply total sales or receipts.

For self-employed and mixed-income earners, the general computation is:

Particulars	Treatment
Gross sales or receipts	Income from business or professional activities
Less: Cost of sales or services	Deductible, when applicable
Gross income from operations	Remaining income after cost of sales/services
Less: Deductions	Itemized deductions or Optional Standard Deduction (OSD)
Net income from operations	Income after deductions
Add: Non-operating income	Income not subject to final tax
Taxable income	Amount subject to graduated rates

Taxpayers generally choose between:

• Itemized deductions – Actual allowable business expenses supported by the required records and documents.

• Optional Standard Deduction (OSD) – A deduction equal to 40% of gross sales or receipts, subject to the applicable rules.

Remember: The 40% OSD is not deducted on top of itemized deductions. It is an alternative deduction method.

For compensation income earners, taxable compensation income is generally determined after applicable exclusions and allowable adjustments.

1. Regular / Ordinary Normal Income Tax:

E. Computation Based on Taxpayer Classification

1. Compensation Income Earner

• Income comes solely from employment.

• Uses the graduated income tax rates.

• The employer generally withholds income tax from compensation.

• Cannot elect the optional 8% income tax because the option is not available to compensation-only employees.

2. Self-Employed Individual

• Income comes from business or professional activities.

• May use graduated rates or elect the 8% optional income tax, if qualified.

• Under graduated rates, allowable deductions may be claimed.

• Under the 8% option, the tax base is generally gross sales or receipts and other non-operating income, subject to the statutory deduction for qualified self-employed taxpayers.

3. Mixed-Income Earner

• Earns both compensation and business or professional income.

• Compensation income remains subject to graduated rates.

• Business or professional income may be taxed using graduated rates or the optional 8% rate, if qualified.

• The ₱250,000 deduction is not available against the business or professional income when using the 8% option.

2. Optional 8% Income Tax

A. Meaning and Purpose

The optional 8% income tax is an alternative tax rate available to qualified self-employed and mixed-income earners.

It was introduced under the TRAIN Law, effective 2018, to provide a simpler tax option for qualified small taxpayers.

The 8% tax is imposed in lieu of:

1. The regular graduated income tax on the qualified business or professional income; and

2. The 3% percentage tax otherwise imposed on non-VAT taxpayers under the applicable rules.
   
   
   

B. Who May Elect the 8% Tax?

Generally, the option is available to:

• Self-employed individuals; and

• Mixed-income earners.

The taxpayer must be qualified as a non-VAT taxpayer and must not exceed the applicable VAT threshold of ₱3 million in gross sales or receipts and other non-operating income, based on the class materials.

For mixed-income earners, compensation income is excluded when determining whether the business or professional income meets the threshold.

C. Tax Base and Computation

The 8% tax is generally computed on gross sales or receipts and other non-operating income, less the applicable statutory deduction where allowed.

Taxpayer	Tax Base
Self-employed individual	Gross sales or receipts and other non-operating income, less ₱250,000
Mixed-income earner	Gross sales or receipts and other non-operating income, without the ₱250,000 deduction

Important: The ₱250,000 deduction is available only to qualified self-employed individuals. Mixed-income earners cannot deduct it from their business or professional income under the 8% option.

2. Optional 8% Income Tax: Election, VAT Threshold, Comparison on Graduated rates vs. 8% option

D. Election of the 8% Tax

A qualified taxpayer must signify their intention to use the 8% tax upon filing the first quarterly income tax return or first quarterly percentage tax return, or upon registration with the BIR, as applicable.

Once elected:

• The choice is irrevocable for the entire taxable year.

• The taxpayer cannot switch to graduated rates in the second or later quarters of that same year simply because they changed their mind.

• The taxpayer may make a different election in the following taxable year, provided they remain qualified.

E. What Happens if the Taxpayer Exceeds the VAT Threshold?

If the taxpayer exceeds the applicable VAT threshold during the taxable year:

1. The 8% election is automatically revoked.

2. The taxpayer becomes subject to graduated income tax rates.

3. The graduated rates apply retroactively from January 1 of that taxable year.

4. Previous 8% tax payments are credited against the resulting tax due.

5. The taxpayer must comply with the applicable VAT registration and business tax requirements.

F. Comparing Graduated Rates and the 8% Option

The best tax option depends on the taxpayer's income, deductions, and applicable business taxes.

A taxpayer should compare the total tax liability, not just the income tax amount.

Comparison	Graduated Income Tax	Optional 8% Income Tax
Tax rate	0%–35%	8%
Tax base	Net taxable income	Gross sales or receipts and other non-operating income, subject to applicable deduction
Business deductions	Itemized deductions or OSD	Generally not deductible
₱250,000 deduction	Reflected in the graduated tax brackets	Available only to qualified self-employed individuals
3% percentage tax	Generally applicable to non-VAT taxpayers	Replaced by the 8% option
Election	General income tax method	Must be elected and is irrevocable for the year

3. Final Tax on Certain Passive Incomes

A. Meaning of Passive Income

Passive income refers to income earned without the active pursuit or performance of trade or business.

Examples include:

• Interest earned from bank deposits;

• Royalties;

• Dividends; and

• Certain prizes and winnings.

Passive income is generally subject to final withholding tax (FWT) at specific rates rather than being included in the regular graduated income tax computation.

The final tax is withheld at source. Once the applicable final tax is paid, the income is generally no longer included in the taxpayer's regular taxable income.

B. Active Income vs. Passive Income

The classification depends on the nature of the taxpayer's activity and how the income is earned.

Active Income	Passive Income
Earned through active business or professional activities.	Earned without actively conducting trade or business.
Generally included in regular taxable income.	May be subject to final withholding tax.
Example: Interest earned by a lending business.	Example: Interest earned by an individual from a bank deposit.

Remember: Interest income is not automatically passive. If a lending company earns interest as part of its ordinary business operations, that interest is active income and is generally subject to regular income tax.

C. Final Tax on Passive Income

The following are the rates discussed in the class materials. The applicable rate depends on the type of income and taxpayer classification.

Type of Passive Income	Tax Treatment in Notes 1 and 2
Interest from peso bank deposits	Generally 20% final tax for resident citizens; certain nonresident individuals are exempt under the stated rules.
Interest from foreign currency deposits	15% final tax for resident citizens under the older treatment reflected in the notes.
Royalties from books, literary works, and musical compositions	10% final tax.
Other passive royalties	20% final tax.
Prizes exceeding ₱10,000	20% final tax.
Prizes of ₱10,000 or below	Subject to regular income tax.
PCSO/Lotto winnings exceeding ₱10,000	20% final tax.
PCSO/Lotto winnings of ₱10,000 or below	Tax-exempt under the class materials.
Cash or property dividends from domestic corporations	Rate depends on the taxpayer's classification.
Share in the net income of a business partnership other than a general professional partnership	Generally subject to final tax treatment similar to dividends.

For dividends, the class notes identify the following rates:

Taxpayer Classification	Dividend Tax Rate
Resident citizen, nonresident citizen, and resident alien	10%
Nonresident alien engaged in trade or business	20%
Nonresident alien not engaged in trade or business	25%

D. Philippine-Source vs. Foreign-Source Passive Income

The source of the income matters when determining whether final tax applies.

• Philippine-source passive income: May be subject to final withholding tax under the applicable provisions.

• Foreign-source passive income: For resident citizens, generally included in regular taxable income rather than being subject to Philippine final tax on domestic passive income.

E. Income Not Subject to Final Tax

Not all passive-looking income automatically qualifies for final tax.

If an income item is not covered by a specific final tax provision, it may remain subject to regular income tax and must be included in taxable income, subject to the applicable rules.

4. Capital Gains Tax (CGT)

Capital Gains Tax is imposed on certain gains from the sale, exchange, or disposition of capital assets. Under Module 5, the main focus is on shares of stock and real property.

A capital asset is generally property held by the taxpayer that is not:

• Inventory or stock in trade;

• Property held primarily for sale to customers in the ordinary course of business; or

• Depreciable property used in business.

A. CGT on the Sale of Shares of Stock

A 15% capital gains tax generally applies to the net capital gains from the sale, exchange, or disposition of shares of stock in a domestic corporation that are not traded through the local stock exchange and are classified as capital assets.

Type of Share Transaction	Tax Treatment
Shares not traded through the local stock exchange and held as capital assets	15% CGT on net capital gains
Shares listed and traded through the local stock exchange	Stock Transaction Tax (STT), not the 15% CGT

B. Computation of CGT on Shares
NetCapitalGain=SellingPrice-Cost

C. Annual Consolidation of Share Transactions

Capital gains and losses from covered share transactions are considered together in determining the net capital gain for the taxable year, subject to the applicable rules.

PowerPoint example:

Transaction	Capital Gain / (Loss)
Transaction 1	₱3,000,000
Transaction 2	(₱2,500,000)
Transaction 3	₱1,500,000
Net Capital Gain	₱2,000,000

CGT:

\[ ₱2,000,000\times15\%=\boxed{₱300,000} \]

4. Capital Gains Tax (CGT): D. CGT on the Sale of Real Property

4. D. CGT on the Sale of Real Property

A 6% CGT generally applies to the sale, exchange, or disposition of Philippine real property classified as a capital asset.

Unlike CGT on shares, the 6% tax on real property is based on a presumed gain. This means the tax is imposed on the property's prescribed tax base, even if the seller did not actually earn a profit.

Tax base:

The 6% CGT is computed using the highest among:

1. Selling price;

2. BIR zonal value; or

3. Fair market value determined by the local assessor.

CGT = Highest Tax Base * 6%

Example:

Basis	Amount
Selling price	₱3,000,000
BIR zonal value	₱3,500,000
Assessor's market value	₱3,200,000
Tax base	₱3,500,000

\[ ₱3,500,000\times6\%=\boxed{₱210,000} \]

4. Capital Gains Tax (CGT): E. Capital Asset vs. Ordinary Asset

The classification of the property determines whether the 6% CGT applies.

Capital Asset	Ordinary Asset
Property not used as inventory or primarily held for sale to customers in the ordinary course of business.	Property held for sale to customers in the ordinary course of business, inventory, or property used in business and subject to depreciation.
Covered by the 6% CGT when the applicable requirements are met.	Generally subject to regular income tax and applicable business taxes instead of the 6% CGT.

Example:

• An individual sells a personal residential lot that was held as an investment. It may be classified as a capital asset.

• A real estate developer sells a residential lot held as inventory. It is an ordinary asset because it is part of the developer's regular business.

4. Capital Gains Tax (CGT): E. Capital Asset vs. Ordinary Asset

F. Sale of a Principal Residence

An individual may qualify for an exemption from the 6% CGT when selling their principal residence, provided all legal conditions are met.

The principal residence exemption is intended to allow an individual to sell their existing home and use the proceeds to acquire or construct another principal residence.

Conditions:

1. The seller must be a natural person.

2. The property sold must be the seller's principal residence.

3. The proceeds must be fully or partially used to acquire or construct a new principal residence within 18 months from the sale.

4. The seller must notify the BIR of the intention to avail of the exemption.

5. The exemption may generally be availed of only once every 10 years.

6. The historical cost of the old residence is carried over to the new principal residence.

7. The computed CGT must be deposited under the required escrow arrangement, subject to the applicable rules.

Full vs. Partial Utilization

• Full utilization: If all the proceeds are used to acquire or construct the new principal residence, the sale may be fully exempt from CGT.

• Partial utilization: If only part of the proceeds is used, the unused portion remains subject to CGT.

Formula for partial utilization:

CGTPayable=EntireCGT * UnutilizedProceeds/TotalProceeds

Formula for the adjusted cost of the new principal residence:

AdjustedCost=OldCost * UtilizedProceeds/TotalProceeds

Example:

Suppose:

• Total proceeds from the sale: ₱5,000,000

• Amount used to acquire a new principal residence: ₱4,000,000

• Unutilized proceeds: ₱1,000,000

• Entire CGT: ₱300,000

Unutilized portion:

\[ \frac{₱1,000,000}{₱5,000,000}=20\% \]

CGT payable:

\[ ₱300,000\times20\%=\boxed{₱60,000} \]

The remaining 80% of the proceeds was utilized, so the corresponding portion may qualify for exemption, assuming all other conditions are satisfied.

What if the seller fails to meet the conditions within 18 months?

Under the class discussion, the escrowed amount is applied against the CGT liability. The seller may also become liable for the applicable surcharge and interest because the original payment deadline has passed. The exact penalties and computation should follow the applicable BIR rules.

4. Capital Gains Tax (CGT): G. Sale of Real Property to the Government

   
   

G. Sale of Real Property to the Government

When an individual sells or transfers real property classified as a capital asset to the government, including through expropriation or eminent domain, the seller may generally choose between:

Option	Tax Treatment
Regular income tax	Graduated rates apply to the gain, with the property's cost taken into account.
6% CGT	Based on the applicable prescribed tax base, without deducting the property's cost.

The seller should compare both methods and choose the one that results in the lower tax liability.

Example:

If the property is sold to the government at a loss:

• Under regular income tax, the sale may produce no taxable gain.

• Under the 6% CGT, tax may still be due because the tax is based on the prescribed value, not the actual gain.

Therefore, the regular income tax option may be more favorable in a loss situation.

The class materials also distinguish the treatment of corporations: the special option discussed above is for individual taxpayers, while a corporation's sale of real property classified as a capital asset is generally subject to the applicable 6% CGT.

5. Fringe Benefits Tax (FBT)

5. Fringe Benefits Tax (FBT): Requisites and Meaning

A. Meaning of Fringe Benefits

A fringe benefit is any good, service, or other benefit given by an employer to an employee in addition to or separate from basic salary.

Examples include:

• Housing benefits;

• Company vehicles;

• Expense accounts;

• Foreign travel expenses;

• Personal expenses paid by the employer; and

• Other benefits provided for the employee's personal use.

FBT is a final withholding tax imposed on the grossed-up monetary value of fringe benefits granted to managerial or supervisory employees.

B. Who Is Subject to FBT?

FBT treatment depends on the employee's classification.

Employee Classification	Tax Treatment
Managerial employees	Fringe benefits generally subject to FBT.
Supervisory employees	Fringe benefits generally subject to FBT.
Rank-and-file employees	Benefits are generally included in gross compensation income and subject to regular income tax, rather than FBT.

Managerial employees are those who have the authority to establish and execute management policies or make decisions involving the hiring, transfer, suspension, discharge, assignment, or discipline of employees.

Supervisory employees are those who effectively recommend managerial actions involving employees, where their recommendations are given particular weight.

Rank-and-file employees are employees who do not hold managerial or supervisory positions.

C. Who Pays and Remits the FBT?

The employer is responsible for paying and remitting FBT to the BIR.

The tax is not simply deducted from the employee's salary. Instead, the employer computes the grossed-up value of the benefit and pays the applicable tax.

The fringe benefit and the corresponding FBT may generally be treated as deductible business expenses by the employer, subject to the applicable requirements.

5. Fringe Benefits Tax (FBT): D. FBT Rates and Grossed-Up Monetary Value

The value of the fringe benefit given to the employee is treated as the net monetary value. Since the benefit is already net of the tax, it must be grossed up before applying the FBT rate.

Taxpayer Classification	FBT Rate	Divisor
Resident citizens	35%	65%
Nonresident citizens	35%	65%
Resident aliens	35%	65%
Nonresident aliens engaged in trade or business	35%	65%
Nonresident aliens not engaged in trade or business	25%	75%

Formulas:

GUMV=NetMonetary/ValueApplicable

FBT=GUMV*Applicable FBT Rate

Where:

• GUMV = Grossed-Up Monetary Value

• Net Monetary Value = Value of the fringe benefit received

• Divisor = 65% or 75%, depending on the employee's classification

Example:

An employer grants a resident citizen managerial employee a fringe benefit worth ₱65,000.

Step 1: Compute the grossed-up monetary value.

\[ \frac{₱65,000}{65\%}=₱100,000 \]

Step 2: Compute the FBT.

\[ ₱100,000\times35\%=\boxed{₱35,000} \]

The employer must remit ₱35,000 in FBT.

Remember: Do not simply multiply the ₱65,000 benefit by 35%. The amount given is already net of tax, so it must first be grossed up.

5. Fringe Benefits Tax (FBT): E. Determining the Net Monetary Value

The net monetary value depends on the form of the benefit:

Type of Benefit	Net Monetary Value
Cash benefit	Amount of cash granted.
Property with transfer of ownership	Market value of the property.
Property without transfer of ownership	Depreciation value of the property, based on the applicable rules.

5. Fringe Benefits Tax (FBT): F: Benefits and Deadline

F. Benefits Not Subject to FBT

Certain benefits are excluded from FBT under the applicable provisions.

Examples include:

1. Benefits required by the nature of, or necessary to, the trade or business, or for the convenience and advantage of the employer.

2. Qualified scholarship grants, provided the required conditions are met, including the employee's obligation to remain employed for a specified period and the relationship of the course to the employer's business.

3. 13th-month pay and other benefits within the ₱90,000 exemption ceiling.

4. Benefits granted to rank-and-file employees, which are generally subject to regular compensation income tax instead.

5. De minimis benefits within the prescribed limits.

Example: Company reimbursement

If an employee uses company funds for a legitimate business expense and submits supporting documents in the company's name, the reimbursement is generally not a taxable fringe benefit.

However, if the employer pays for an employee's personal expenses, the payment may be considered a fringe benefit.

G. Deadline for FBT Remittance

The employer must remit the FBT on or before the last day of the month following the close of the calendar quarter in which the withholding was made.

Quarter	Remittance Deadline
1st Quarter	April 30
2nd Quarter	July 31
3rd Quarter	October 31
4th Quarter	January 31 of the following year

6. De Minimis Benefits: A. Meaning

A. Meaning of De Minimis Benefits

De minimis benefits are benefits of relatively small value provided by employers to promote employee welfare, satisfaction, and goodwill.

These benefits are generally exempt from both:

• Fringe Benefits Tax; and

• Regular income tax.

They may be granted to managerial, supervisory, and rank-and-file employees, provided they fall within the prescribed categories and limits.

Important: The list of de minimis benefits is specific. A benefit does not automatically qualify just because it is inexpensive or has a small value. It must fall under a recognized category and comply with the applicable ceiling.

6. De Minimis Benefits: B. De Minimis Benefits and Their Ceilings

B. De Minimis Benefits and Their Ceilings

The following are the ceilings presented in the lecture notes:

De Minimis Benefit	Ceiling
Monetized unused vacation leave credits of private employees	Up to 12 days per year
Monetized unused vacation and sick leave credits of government employees	No maximum number of days under the stated rule
Medical cash allowance to dependents	₱2,000 per employee per semester
Rice subsidy	₱2,500 per month
Uniform and clothing allowance	₱8,000 per annum
Actual medical assistance	₱12,000 per annum
Laundry allowance	₱400 per month
Employee achievement awards	Up to ₱12,000 per annum
Christmas and major anniversary gifts	Up to ₱6,000 per annum
Daily meal allowance for overtime work	Not exceeding 30% of the basic minimum wage
Benefits under CBA and productivity incentive schemes	Combined limit of ₱12,000 per annum

Tax regulation note: These amounts are the ceilings recorded in Notes 2. Some de minimis ceilings have been amended through BIR issuances, so verify the current applicable limits before using these figures for an actual tax filing or computation.

6. De Minimis Benefits: C. Treatment of Excess De Minimis Benefits

C. Treatment of Excess De Minimis Benefits

What happens when an employer grants a benefit that exceeds its prescribed de minimis ceiling?

The amount exceeding the ceiling is generally treated as part of the employee's 13th-month pay and other benefits, subject to the combined ₱90,000 exemption ceiling.

The treatment follows this sequence:

1. Identify the actual benefit received.

2. Deduct the maximum amount allowed as a de minimis benefit.

3. Treat the excess as part of 13th-month pay and other benefits.

4. Combine it with the employee's other 13th-month pay and benefits.

5. Apply the ₱90,000 exemption ceiling.

6. Any amount exceeding ₱90,000 becomes taxable under the applicable employee classification.

Employee Classification	Treatment of Taxable Excess
Managerial or supervisory employee	Generally subject to FBT, where the applicable rules classify the excess as a fringe benefit.
Rank-and-file employee	Generally subject to regular income tax as compensation income.