As a business, you are allowed a deductible expense to lower your tax dues. This tax avoidance measure is legal, provided you comply with the documentation requirements of the BIR. So, from business-related expenses to charity donations, you can claim them as deductibles to lessen your tax obligations. You have two deduction schemes to choose from: optional standard deduction (OSD) or itemized deduction (ID).
Now, the question is, which among these two schemes will serve your business well? Unfortunately, there is no clear-cut answer as it depends on a broad range of factors. But, of course, the general advice is to choose the option that will give you the highest deductions because it equates to lesser tax bills.
However, you must note that each scheme comes with its advantages and disadvantages. This short article covers those details. For best results, consult a professional accountant so you can maximize your deductibles. This ensures you are doing proper tax avoidance but not tax evasion. Let’s get started!
The Low-Down on Itemized Deductions
Unlike the standard version, this deduction scheme offers more flexibility. It lives up to its name as you must itemize or write down all your valid deductible expenses. This offers the following advantages:
- Can result in higher deductions
The OSD caps your deductions at 40% of your gross income. This can be quite limiting if you have huge direct costs and operating expenses like rentals, utilities, and salaries. However, since the Itemized Deduction scheme offers more flexibility, you can claim a much higher deduction. As a result, you can lower your tax dues even more.
- Protection in case of income loss
Another major benefit of the Itemized scheme is that you won’t be required to pay income tax if you incur losses during the taxable year. This is a major reprieve when money is tight. However, this is not the case with the OSD.
The Itemized Deduction scheme has its own unique quirks that make it far from perfect. Take a look at them below:
- Keeping documentary evidence
The burden of proof is in your hands, so this means you must be diligent in keeping all the official receipts and other evidence of your expenses. On top of that, you are required to store these documents for up to 10 years in case you are audited. For a busy entrepreneur, it can be very cumbersome to do this. However, many still opt for the ID scheme because of its benefits.
- Required CPA input
Should your annual sales or receipts exceed P3 million, you must seek the services of a Certified Public Accountant (CPA). This is because the BIR requires a CPA to audit your records to ensure accuracy. However, some businessmen do not like this because it means paying and consuming resources for bookkeeping and managing fiscal health.
The Nuances of the Ordinary Standard
As its name implies, this deduction scheme sets a standard that’s quite simple and predictable. Here, individual taxpayers can declare 40% of gross sales or receipts. Meanwhile, partnerships and corporations can declare up to 40% of their gross income. Take note of the difference when declaring your business expenses, of which the rest of the 60% becomes taxable.
In this scheme, you do not need to substantiate your claims with documents. However, you are still required to keep records of actual business expenses for examination purposes. This is a requirement of the BIR, so don’t be remiss in this obligation. Here are the primary benefits of the OSD
- Ideal for small businesses
This OSD scheme is very ideal for small to medium-scale enterprises that have low operating expenses. There is not much advantage for you in itemizing everything in this scenario because your costs are low, to begin with.
- No CPA requirement
Another nice feature of this deductible scheme is you can do it on your own. You don’t have to pay extra for a CPA. All you must do is submit an Account Information Return (AIF) or financial statement. This is mandated in the Tax Code.
The major disadvantage of the OSD scheme is that 60% of your earnings are automatically taxed. This ruling applies whether you made a profit or not. This can be very cumbersome and equate to losing money if your business expenses exceed your revenues.
Some Vital Things to Remember
As a business owner, here are some things to remember as you decide between the two deductible options:
- Use One Scheme for the Year
You must remember that you cannot change your mind in the middle of the taxable year. If you already opted for the itemize deduction scheme during the first quarter, you have no other recourse but to stick with it unit the three quarters are done. You can revert to a new scheme later on when the year is done.
- Non-resident Aliens Do Not Get a Choice
Unfortunately, non-resident aliens who engage in business or trade in the Philippines do not get a choice between the two deductible schemes. As a foreigner engaged in business in the country, you have to use the ID scheme only.
- Make Sure Deductibles are Legit
When claiming deductibles, make sure that all your expenses are indeed included in the BIR’s list of deductible expenses. Only those on the list will be considered. Examples of these are:
- Charity work
- Research and development
- Assess the Expense Criteria of the BIR
The bureau sets the specific criteria that all businesses must meet. For example, your expenses must fall under the following categories:
- Related to business
- Must be legal
- Come with supporting documents
- Must have paid withholding taxes
- The deduction amount must be reasonable
Pinpointing the Ideal Deductible Scheme Option for Your Business
After covering the general information of both deductible schemes, you can decide which one is most optimal for your business. Remember, each business owner faces varying situations and must weigh different factors before making a choice. Again, it would be helpful to seek the advice of a professional accountant to review your books and offer the best solution.
If you need help, our experienced accounting and tax professionals can help sort out details. We will review your financial statements to evaluate which is the most advantageous scheme for you. Our team can also help you with bookkeeping, accounting, and auditing to ensure you pay the correct taxes on time. With the right advice that’s suited to your unique company needs, you can save your resources. Give us a call for a free 30-minute consultation.