Tax Articles

On Optional Standard Deductions

By: Atty. Jomel N. Manaig

Except for certain types of taxpayers or types of income where no deductions or where there are only limited deductions in the computation of income taxes due, individual and corporate income taxpayers are generally entitled to claim deductions in computing their net income subjected to income tax. Traditionally, these are the costs and expenses incurred by the taxpayer in earning the taxable income or in running the business.

In lieu of reporting the individual/itemized deductions, the current law allows the taxpayer to elect a standard deduction (of 40%) in the computation of net taxable income. This option is usually referred to as the optional standard deductions or OSD. While this is available to both corporate and individual taxpayers, there is a difference in the basis of the 40%. For corporate taxpayers, the 40% is computed on the gross income while for individuals, it is based on the gross sales or gross receipts.

But note that when the OSD was first introduced in our income tax system, the same was available only to individual taxpayers. The privilege to choose OSD was not available to corporate taxpayers. In its original conceptualization, only individual taxpayers were given the option to claim a specific percentage of the gross income as deduction in the computation of his income tax liability, instead of identifying each item of expenses. And as opposed to the current rules, when the OSD was first introduced in our tax system for the individuals, the basis of the 10% (OSD rate at that time) standard deduction was the gross income and not the gross sales or receipts.

Subsequent revisions, however, in the Tax Code included some changes in the OSD rules. Republic Act No. 8424 or the National Internal Revenue Code of 1997 retained the same privilege for individual taxpayers, allowing them to elect a standard deduction in an amount not exceeding ten percent (10%) of their gross income. That same option was not yet made available to corporate taxpayers.

The situation was significantly changed in 2008 when Republic Act No. 9504 introduced amendments to the National Internal Revenue Code of 1997. On the OSD, the following were the significant changes made: (1) the OSD rate was increased four times from 10% to 40%; (2) for individuals, previous computation of the OSD based on gross income was changed to gross sales or gross receipts; and (3) the inclusion of corporate taxpayers from those entitled to avail of the OSD.

Implementing this was RR 16-08, which emphasized, among others that the OSD allowed to individual taxpayers shall be a maximum of forty percent (40%) of gross sales or gross receipts during the taxable year. It further emphasized that the "cost of sales" in case of individual seller of goods, or the "cost of services" in the case of individual seller of services, are not allowed to be deducted for purposes of determining the basis of the OSD, inasmuch as the law (RA 9504) is specific as to the basis thereof.

Compare this to corporate taxpayers. The OSD allowed shall be in an amount not exceeding forty percent (40%) of their gross income. Corporations are allowed to deduct the cost of sales from the sales to arrive at the gross income, and from the gross income the OSD is computed and deducted to arrive at the net taxable income. For the individuals, on the other hand, the OSD is computed and deducted from the gross sales/receipts to arrive at the net taxable income.

Effectively, in computing the net taxable income for individual taxpayers using the OSD, the cost of sales or cost of services are not allowed as deductions. And so there is a marked distinction in the computation of net taxable income for individual taxpayers and corporate taxpayers electing to compute the income tax liability using the OSD method.

As I noted earlier in this column, the original target of the OSD method of computation were the individual taxpayers to simplify their tax filing. And from the birth of the OSD, the deductibility of costs of sales/services was recognized for individuals even when availing of the OSD, allowing them to compute the standard deduction based on the gross income. Why had this suddenly changed when the same option was extended to corporate taxpayers? I am not sure of the answer, but I see no reasonable reason.

A law pending in Congress seeks to standardize the availment of optional standard deduction for taxpayers and eliminate the difference between corporate and individual taxpayers. This is certainly a welcome development for individual taxpayers. Hence, we hope that this bill will be passed soon.

In addition to the change to gross income for individual taxpayers, perhaps the proviso on general professional partnerships and their partners should also be modified. The proviso currently provides that the GPP or the partner shall avail of the OSD only once, either by the GPP or by the partner. That seems to be anchored on the fact that individuals claim OSD based on the gross sales/receipts. With the proposed amendment, the proviso may simply state – a partner opting to avail of the standard deduction shall report his share in the gross income of the GPP and claim the OSD based on his reported share in the gross income of the firm. That effectively allows the individual to claim his proportionate share in the cost of sales/services of the firm and at the same time allowing him to claim OSD.