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Lecture 2a Deductions From Gross Income
Lecture 2a Deductions From Gross Income
Lecture 2a Deductions From Gross Income
Deductions from gross income depends upon the taxpayer and his source of income.
GENERAL RULE:
Must point to some specific provisions of the statute authorizing the deduction
Must be able to prove that he is entitled to the deduction authorized or allowed
1. Optional standard deduction of 40% may be claimed in lieu of the itemized deductions.
2. A taxpayer who opts to avail of this deduction need not submit the Account Information Form (AIF)/
Financial Statements.
3. Individual taxpayers (RC, NRC, RA, taxable estates and trusts) who are engaged in business or selling of
service may claim OSD, except NRAETB and NRANETB. For individual taxpayers, the 40% OSD is
multiplied at his gross sales or gross receipts. For purposes of computing OSD for individuals, gross
sales/receipts shall mean after deducting sales discounts actually taken, sales returns and sales
allowances.
4. Corporate taxpayers (domestic and resident foreign), except non-resident foreign corporation, may claim
40% OSD of its gross income (sales/receipts less cost of sales/service plus other income not subjected to
final tax).
5. The selection is not presumed; the taxpayer should signify his election to claim OSD and such would be
irrevocable for the taxable year in which the return is made.
6. The failure to indicate the election to avail the OSD shall be considered as having availed of the itemized
deductions.
2. Interests
a. There must be an indebtedness which pertains to the taxpayer.
b. The indebtedness must be connected to the business, trade or profession of the taxpayer.
c. There must be a legal (enforceable by law) liability to pay interest.
d. It must be paid or incurred during the taxable year.
e. It must be subjected to the following limit:
Interest expense, incurred or paid (depending whether accrual or cash basis) xx
Less: total interest income subjected to final tax times 33% (xx)
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Lecture: Deductions from Gross Income and Losses
3. Taxes
a. Taxes paid or incurred within taxable year in connection with the taxpayer’s business, trade or
profession, shall be allowed as deduction.
b. The following taxes are not deductible:
1. Income tax
2. Income tax paid abroad, IF claimed as tax credit
3. Estate tax
4. Donor’s tax
5. Value-added tax
6. Special assessment
4. Losses
a. The following losses may be claimed as deduction:
1. Casualty losses
2. Net Operating Loss Carry-Over (NOLCO)
3. Capital losses – see discussions on Dealings in Property
4. Special losses
i. Losses from wash sales of stock or securities
ii. Wagering losses
iii. Abandonment losses
iv. Securities becoming worthless
b. Requisites:
1. The loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or
embezzlement;
2. The property lost is connected with the trade business or practice of profession;
3. Actually sustained during the taxable year;
4. Not compensated for by insurance or other forms of idemnity;
5. Incurred in trade, profession or business;
6. Reported with the BIR within forty-five days from the time of loss; and
7. Not claimed as deduction for estate tax purposes.
Notes to remember:
a. The following taxpayers are permitted to deduct NOLCO from their gross income:
i. Individual taxpayers engaged in trade or business or in the exercise of profession;
ii. Domestic and resident foreign corporation subject to normal income tax (20%).
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iii. Special corporation subject to preferential tax rates such as private educational
institutions, hospitals, and regional area headquarters
b. Any persons, natural or juridical, enjoying exemptions from income tax pursuant to the
provisions of the Tax Code and any special law shall not be entitled to deduct NOLCO from
gross income.
e. Abandonment losses
1. In the event a contract area where petroleum operations are taken is partially or wholly abandoned,
all accumulated exploration and development expenditures pertaining thereto shall be allowed as
deduction.
2. In case a producing well is subsequently abandoned, the unamortized costs thereif, as well as the
undepreciated costs of equipment directly used therein, shall be allowed as deduction.
3. If the abandoned well is re-entered and production is resumed or equipment is restored into
service, the effects are:
The amount previously claimed as deduction shall be recognized as income; and
Such amount shall also be capitalized and amortized or depreciated, as the case may be.
5. Bad Debts
a. Requisites:
1. There must be an existing debt due to the taxpayer which must be valid and legally demandable.
2. The same must be connected with the taxpayer’s trade, business or practice of profession.
3. The same must not be sustained in a transaction between related taxpayers.
4. The same must be actually written off in the books of accounts of the taxpayer as of the end of the
taxable year.
5. The same must be actually ascertained to be worthless and uncollectible.
6. Accounts previously written off which are later recovered shall be taxable to the extent of the
amount which benefited the taxpayer, meaning the tax shield which was availed and for which
had benefited the taxpayer
6. Depreciation
a. Requisites:
1. The property subject to depreciation is used in the trade, business or practice or profession.
2. The allowance for depreciation must be sustained by the person who owns or who has a capital
investment in the property.
3. The allowance for depreciation must be reasonable.
4. The allowance for depreciation should not exceed the cost of the property.
5. The schedule of the allowance must be attached to the return.
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e. In the case of a nonresident aliens engaged in trade or business or a resident foreign corporation,
depreciation shall be allowed only if the property is located in the Philippines.
f. Allowance for obsolescence may be deducted in addition to the reasonable allowance for the
exhaustion, wear and tear.
7. Depletion
a. In case of oil and gas wells or mines, capital invested may be amortized using the cost-depletion
method, provided:
1. When allowance for depletion shall equal to capital invested, and no further allowance shall be
granted.
2. Afte production in commercial quantities has commenced, intangible exploration and
development drilling costs shall be treated as
i. If incurred for non-producing wells and/or mines, deductible in the year incurred.
ii. If incurred for producing wells and/or mines:
Deductible in full in the year paid or incurred; or
Capitalized and amortized
b. In the case NRAETB or resident foreign corporation, depletion shall be allowed only if the oil and gas
wells or mines are located in the Philippines.
8. Charitable Contribution
1. Fully deductible contributions:
a. Donations to the Government of the Philippines or any of its agencies or political subdivisions
including fully owned government corporations, exlusively to be used in undertaking priority
activities in Education, Health, Youth, Sports Development, Human Settlements, Science and
Culture, and Economic Development.
b. For corporations, the limit is 5% of the taxable income from trade or practice of profession
before the deduction for charitable contributions.
c. For individuals, the limit is 10% of the taxable income from trade or practice of profession
before the deduction for charitable contributions.
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Past Service Cost is the excess of actual contributions over the Normal Cost. It shall be
amortized over ten (10) years.
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