CHAPTER 13-C

OPTIONAL STANDARD DEDUCTIONS

Learning Objectives:
This chapter, readers are expected to demonstrate:
1. Understanding of the nature of the optional standard deduction (OSD)
2. Knowledge of the taxpayers who can claim the OSD
3. Comprehension of the concept of operating income or revenue and a non-operating income for individual
taxpayers
4. Comprehension of the rules of OSD for general professional partnership and the partners

OPTIONAL STANDARD DEDUCTION (OSD)

The OSD 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. There is no need to support every item of expense.
The OSD, however, 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?

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/preferential income tax
3. Non-resident alien not engaged in trade or business

PERCENTAGE OF OPTIONAL STANDARD DEDUCTIONS

1. Individual taxpayers - 40% of total sales/revenues/receipts/fees
Those selling goods under the accrual basis - 40% of gross sales
Those selling goods under the cash basis - 40% of gross receipts
Those selling services under the accrual basis - 40% of revenue
2. Corporate taxpayers - 40% of gross income

The Individual OSD

Since 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, such as:

The Corporate OSD

Since the corporate OSD is based on gross income, it is deemed to replace all items of deductions from gross
income in computing net income.

Table of Comparison on OSD:

Individual OSD replaces Corporate OSD replaces
Cost of sales/cost of services? YES NO
Regular Allowable Itemized? YES YES
Special Allowable Deductions? YES YES
Net Operating loss carry-over? YES YES
Personal Exemption? NO Not Applicable
RULES ON DETERMINATION OF OSD FOR INDIVIDUAL TAXPAYERS

Gross Sales - As clarified by RR16-2008, gross sales is the accounting concept of net sales
Gross Receipts - Amounts actually or constructively received during the taxable year or amounts earned as
gross revenue during the taxable year.

The optional standard deduction for individual taxpayers is specifically computed as:

Net Sales/Revenues/Receipts/Fees P xxx,xxx

Add: Other taxable income from operation
Not subject to final tax P 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 operations of business or
profession.

Establishment Primary Income Other Operating Income

Retail Stores Sales of Goods Consignment commission
Display rack rental
Manufacturing Business Sales of Goods Sale of scrap
Installment Dealers Sales of Goods Interest Income
Accounting Firm Professional Fees Income from seminars
Interest from client notes
Reimbursement for out-of-pocket
expenses

Non-operating income
1. Gains from dealings in properties
2. Distribution from a GPP, 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

RULES ON DETERMINATION OF OSD FOR CORPORATE TAXPAYERS

Gross Income
Under NIRC, gross income was restrictively defined as:
a. The 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 amendment 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 corporate OSD is computed as
follows:

Net Sales/Revenues/Receipts/Fees P xxx,xxx

Less: Cost of sales or services P xxx,xxx
Gross income from operations P xxx,xxx
Add: Other taxable income, not subject to final tax P xxx,xxx
Total Gross income P xxx,xxx
Multiply by: OSD percentage 40%
Optional Standard Deduction P xxx,xxx

OSD FOR GENERAL PROFESSIONAL PARTNERSHIPS

A GPP is not a taxable entity. It is merely viewed as a “pass-through” entity where income is ultimately taxed
to the partners. Each partner shall report as gross income his distributive share, actually or constructively
received, in the net income of the GPP.
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.

Thus, the GPP can choose either the itemized deduction or the optional standard deduction in computing its
net income. The allowable deduction for a GPP electing to deduct OSD shall be 40% of gross income similar to
corporations.

Deduction against partner’s share in net income

A partner can claim itemized deductions which are in the nature of an ordinary and necessary expense for the
practice of profession which were not claimed by the GPP in computing its net income during the year. These
may include expenses incurred by the partner in connection with the performance of his duties to the GPP
that are, by agreement, non-reimbursable by or non-chargeable to the GPP.

Conditions for deductibility of partner’s expenses

A partner can claim only 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.

A partner cannot claim OSD against his share in the net income because the same is an item of gross income,
not a revenue, sale, fee, or receipt. Note that for individual taxpayers, OSD is deductible only against gross
sales, gross receipts, or revenue but not against gross income.

The following table summarizes the rules:

GPP mode of deduction Partner’s mode of deduction Status
Itemized Itemized Allowed
Itemized OSD Not allowed
OSD Itemized Not allowed
OSD OSD Not allowed

Share in the net income vs. Actual profit distribution

The share in the net income is computed from the net income of the GPP as determined by tax rules. The
actual profit distribution is computed from net income as determined by generally accepted accounting rules.
The latter 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 GPP