In a previous post, we talked about allowable deductible expenses, which ranged from business-related expenses to donations to charitable institutions. We also mentioned that as a taxpayer, you have the option between two deduction schemes: itemized deduction and optional standard deduction OSD.
So which one is right for your business? It depends on a wide range of factors, but as a general rule, it is ideal that you choose the scheme that will allow you to claim higher deductions. However, keep in mind that each option has its own set of pros and cons, which we’ll cover in detail in this article. To get advice specific to your situation or business, please consult with a professional tax services consultant or an accountant.
To begin, let’s talk about itemized deductions.
Itemized Deductions: Flexibility at a Cost
As the name would suggest, this deduction scheme requires you to declare all your valid deductible expenses (please refer to our article ‘What You Need to Know About Deductible Expenses’ for more information). This offers a couple of advantages.
The first one is that itemized deductions offer more room for flexibility, because it can potentially result in deductions higher than what you can apply for with the OSD, which is capped at 40% of your gross income. This is especially the case if you have huge direct cost and operating expenses, such as employee salaries, rental, and cost of utilities.
Another benefit is that in case you incur losses during the taxable year, you won’t be required to pay income tax, which isn’t the case with OSD.
However, an itemized deduction scheme also means keeping all the official receipts and other proof of these expenses, required to be stored up to 10 years.. Of course, doing this can be quite tedious, however it may be balanced out by its advantages over OSD. Finally, should your annual sales or receipts exceed P3,000,000, you will be required to have a Certified Public Accountant (CPA) audit your accounting records, translating to more resources spent on managing your books.
OSD: Simple and Predictable
With OSD, you can declare up to 40% of your gross sales/receipts (for individual taxpayers) or gross income (for partnerships and corporations) as business expenses, of which the remaining 60% will then be taxable.
Along with the fact that you no longer need to substantiate the 40%, taxpayer is still required to keep records of actual business expenses as a requirement for BIR examination purposes.
In addition, OSD is also ideal for businesses with low operating expenses since you may not gain too much advantage from keeping itemized deductions.
Another convenient feature of OSD is that you are no longer required to hire a CPA and submit an Account Information Return (AIF) or financial statements otherwise required under the Tax Code.
On the other hand, the major disadvantage to this is that 60% of whatever you earn is automatically taxed whether or not you made a profit during the period. This could result to you paying more and losing even more money if your expenses exceed your revenue.
Things to Remember
Here are a few things to remember when choosing between the two schemes:
You can use only one scheme for the taxable year. If you already checked the itemized deduction scheme during the first quarter, you have to use itemized deductions for the succeeding three quarters as well.
If you are a non-resident alien engaged in trade or business in the Philippines, you may only opt for the itemized deduction scheme.
Ensure that your expenses are included in the BIR’s list of deductible expenses. These include charitable contributions, advertising, and research and development.
Determine that the expenses meet the criteria set by the Bureau, such as that these should be business-related, have supporting documents, be legal, have withholding taxes paid, and the amount being deducted must be reasonable.
Choosing the Most Ideal Scheme for Your Business
What we covered in this article are general information about each scheme. Because of the intricacies of each individual situation, such as your type of business, it can be difficult to provide any definitive advice on which option is ideal for you without meeting with a professional. We therefore recommend that you seek the advice of a tax consultant or an accountant for more information.
Here at Beyond D Numbers, our experienced and professional accountants are here to help you pay the right taxes with the right advice that’s fit to your unique circumstances. To find out more about how we can assist you with your tax, accounting, and other needs, contact us today.
Disclaimer: Information contained in this article may become outdated and is therefore meant as general guidance only. It is not intended as professional accounting or tax advice.