Graduated Income Tax Rate with OSD vs 8% Income Tax Rate

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If you are a business owner, one of the tasks you need to accomplish is filing your income tax return. The process of filing may seem tedious, especially to an untrained eye. It will require you to monitor the process accurately and to keep an analytical mind. If you have the right strategy, you will be able to save money in your tax remittances. 

This whole process of saving is called tax avoidance, which is entirely different from tax evasion. Tax avoidance is a legal option for businesses to lessen their tax liability. If you want to minimize your dues, tax and audit services in the Philippines attest that tax avoidance is the best way to do it to keep more of your profits. If it is applicable, you can select your income tax rate.

Graduated Income Tax Rate vs. 8% Income Tax Rate

If you are self-employed or a professional, tax services in Manila confirm that you have the option to either choose either the graduated income tax rate with OSD (optional standard deduction) or the 8% tax on gross sales. It is the graduated income tax rate that is widely and commonly used by individual taxpayers. 

The graduated tax follows a set of tax rates that increases when the taxable amount also increases. Some call this a progressive income tax. Accounting services in the Philippines explain that taxpayers have a choice to deduct either 40% of their total sales or income as business expenses, instead of listing individual deductions. This helps determine the amount of income that is subject to taxes. Key points are:

  • Taxpayers don’t need to provide evidence for the 40% business expense deduction, but they should keep records of their actual business expenses in case of an audit by the BIR (Bureau of Internal Revenue).
  • It is no longer necessary to submit an Account Information Return (AIF) or audited financial statements.
  • OSD is particularly beneficial for businesses with minimal expenses because they can deduct a higher percentage (40% of Gross Income or Gross Sales) compared to their actual expenses.
  • The remaining 60% of Gross Income or Gross Sales is automatically taxed, regardless of whether the business made a profit or not during the taxable year. This means you may end up paying more taxes if your expenses exceed your revenue.

In recent years, BIR introduced a new tax scheme under TRAIN law or Tax Reform Acceleration and Inclusion Act called the 8% special tax rate on gross sales. The flat tax rate will be computed based on your total gross sales and other non-operating income over P250,000. If you exceed the VAT threshold during the taxable year, you will be subject to graduated tax rates automatically. In this option, you don’t have to subtract business-related expenses when calculating taxable income. However, if your business has significant operating expenses, you may end up with a higher tax bill when using the 8% Income Tax Rate.

Who can take advantage of the 8% income tax rate? 

Listed below are the people who can avail of the 8% income tax rate. If your gross sales and your non-operating income does not exceed the 3 million pesos VAT threshold for the taxable year, you are qualified to avail of the 8% income tax rate.

  • Individuals who earn purely from business or professional income (Practitioner, Freelancer, etc.)
  • Individuals who earn from self-employment and compensation (a.k.a mixed-income earners)

Note that if your income tax payment is under an 8% income tax rate, it should be allowed as a tax credit.

Who are the exempted individuals?

  • Partnerships, Cooperatives, and Corporations (non-individuals)
  • GPP Partners 
  • Individuals who earn purely from compensation 
  • Taxpayers who are VAT registered
  • Taxpayers who are subject to other special  percentage tax specifically for the purpose of business

How to avail of the 8% income tax rate?

You need to show your intention to file for the 8% income tax rate option for the taxable year. Make sure to signify your intention before the filing in the 1st quarter of ITR. If you don’t, you will be automatically considered as someone availing of the graduated income tax rates.

Which one is better between the two?

The 8% income tax rate option is labeled as a better option compared to the graduated income tax rate option because of its simplicity. However, it depends heavily on your income, expense flow, nature of business, and long term goals. At some point, you may be able to save more from using the graduated income tax rate with the optional standard deduction compared to the 8% income tax rate option.

If you are still unsure about which of the two you should use, it would be prudent to get advice from a certified public accountant. Keep in mind that consulting professionals is the only way to lessen your burdens and confusion. Our team of accounting experts can explain which option is better for you.If you need assistance, don’t hesitate to get in touch with our accounting services in Pasig