If you are an individual whose income is generated from the practice of trade, business, and/or practice of a profession, then you are self-employed. Although it may sound really great because you don’t have a boss to deal, it also comes with its own set of complexities. For starters, you must take care of your own accounting and bookkeeping to ascertain your fiscal health.
On top of that, you need to audit your statements to make sure you pay the correct tax dues to the BIR. Notably, mistakes in calculations and failing to submit supporting documents can result in hefty fines and compounding interest arrears. This also opens you up to a rigorous BIR audit and investigation which can really stress you out. Thus, it is imperative to avoid these potential issues by knowing what all your obligations are.
When you are self-employed, you can legally lower your taxes through deductibles. But you have to carefully document all supporting evidences. When you are self-employed, you are given the choice to elect either Itemized Deductions or Optional Standard Deductions (OSD). Remember that in taxation, ‘one size fit all’ does not apply. It is important to learn about these two as it will help you consider which one of the given choices will fit your situation the most. Let’s learn more about them below:
Itemized Deductions
In itemizing your deductions, you need to list all the expenses that will be subtracted from your gross income in order to reduce or lessen the amount of your taxable income. Bear in mind, you need careful accounting and bookkeeping to list down pertinent transactions. After all, there are only itemized deductions from your gross income that are allowed, and these are the following:
- Salaries and Wages
- Rental
- Communication Expenses
- Office Supplies
- Travel Expenses
- Gasoline and Toll Fees
On top of knowing what are allowed deductibles by the BIR, you will also need to follow the criteria for deductibility. Check out these details that you must be aware of when filing for these itemized deductions:
- The deductions made should be ordinary and must be necessary for the conduct of your business.
- The deductions made should be a reasonable amount.
- The deductions made should be adequately substantiated.
When you have subtracted the itemized deductions from your income, the remaining amount is your taxable income.
Optional Standard Deduction (OSD)
The Optional Standard Deduction or OSD allows you to deduct 40% of your gross income. This means that instead of tracking all your expenses, you can just declare that 40% of your income is your expenses. This is helpful for certain businesses that don’t have a lot of deductibles since they don’t have to rigorously track each transaction and just set a blanket amount right away based on your income.
Which One to Chose
Are you confused about which one of the two deductible options to elect for yourself? To help you, let’s assume that you are a self-employed individual that gains a monthly gross income of 120,00 from rendering services. Just a reminder that this is not advisable for self-employed individuals who sell goods.
Itemized Deduction | Optional Standard Deductions | ||
Monthly Gross Income | 120,000 | Monthly Gross Income | 120,000 |
Itemized Deductions |
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| |
Salaries of Staff | 12,000 |
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|
Rental | 15,000 |
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|
Communication Expenses | 3,000 |
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|
Office Supplies | 1,000 |
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Travel Expenses | 10,000 |
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Gasoline and Toll Fees | 4,000 |
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Total Itemized Deductions | 45,000 | Optional Standard Deduction (40%) | 48,000 |
Net Income | 75,000 | Taxable Income | 72,000 |
As you can see above, when you choose the optional standard deduction, you get to reduce or lessen the amount of taxable income and as a result, lessen the amount of income tax due. This is assuming that you are a self-employed individual who generates profit from rendering services whose monthly gross income is estimated to be 120,000.
Choosing which one from the two will depend on your situation as a self-employed individual. If you own a business that has high operating expenses, you can try considering itemized deductions. The option you must take is the one that gives you the biggest reduction on your overall tax dues.
Bear in mind, elections for which deductible option should be done in the 1st quarter of the year. Remember that what you choose will differ depending on your situation or circumstance. Sometimes, it may make more sense to itemize your deductions than to choose the standard deduction.
The only way to assess which one is right for you is to open your books and analyze your financial statements. If this is confusing for you, it would be prudent to contact a professional accountant. Call our team of CPAs to because we can assist you in choosing what’s the best option for your unique operations. Apart from accounting and bookkeeping, we can audit your books and ensure you stay tax compliant to avoid any repercussions.
