ALLOWABLE DEDUCTIONS FROM GROSS INCOME: Kinds of allowable deductions:

Deductions- amounts which the law allows to be deducted from
gross income in order to arrive at net or taxable income.
EXCLUSION
Flow of wealth which are not
treated as part of the gross
income : a. exempted by law or
statute; b. do not come within
the definition of income
Computation of gross income
Earned by the taxpayer which
do not form part of the gross
income
TAX CREDITS
Amount of tax previously paid
by the taxpayer which later on
can be claimed as tax credit
from the tax liability of the
taxpayer.
Itemized Deductions – expenditure on eligible products, services or
contributions that can be subtracted from adjusted gross income to
reduce tax liability.
DEDUCTION
Amounts which the law allows a. Business expenses
to be subtracted from the gross b. Interest
income in order to arrive at the c. Taxes
net income d. Losses
e. Bad debts
Computation of net income f. Depreciation
Spent or paid in earning the g. Depletion
gross income.
h. Charitable and other contributions
i. Research and development expenditure
j. Pension trust ontribution
DEDUCTION
Optimized Standard Deductions – standard deduction in an amount
Expenses and other allowable
deductions; provided by law not exceeding 40% of the gross sales/receipt of individuals, other
which are incurred for engaging than non-resident aliens or 40% of gross income corporations in lieu
in trade, business or profession, of the itemized deductions
deducted from the gross
NOTE: default deduction is Itemized Deduction—unless taxpayer
income to arrive at the net or
signifies in his return his intention to avail of the OSD—deemed to
taxable income
have availed itemized deductions

Specialized deductions –
Principles:
 Deductions allowed to private proprietary educational
1. Taxpayer seeking a deduction must point to some specific
institutions and hospitals that are non-profit
provision of the statute authorizing the deduction
2. Must be able to prove that he is entitled to the deduction  Allowed to insurance companies
authorized or allowed  Allowed to estates and trusts
COHAN RULE PRINCIPLE – there is showing that expenses have - Does not require that the payments be habitual or normal
been incurred but the exact amount cannot be ascertained due to in the sense that same taxpayer will have will to make them
the absence of documentary evidence. often. – payment may be unique or non-recurring to
particular taxpayer affected.

Necessary – when it is appropriate and helpful in the development

Kinds of Itemized Deductions
of the taxpayer’s business. Intended to realize profit or to minimize
A. Business Expenses a loss
All the ORDINARY and NECESSARY expenses paid or incurred
Capital expenditure – an expenditure that benefits not only
during the taxable year in carrying on or which are directly
the current period but also future periods. It is not
attributable to the development, management, operation
deductible but depreciable
and/ or conduct of the trade, business or exercise of
profession EXCEPT: if the taxpayer is non-profit proprietary
educational institution which may elect either to
deduct the capital expense or depreciate it
Requisites for deductibility:

1. Expense must be ordinary and necessary

2. The expense must be incurred in trade or business The expense must be incurred in trade or business carried on by the
carried on by the taxpayer taxpayer
3. Expense must be substantiated by proof
- This means that the same is not incurred in the trade or
4. Expense must be reasonable
business of another.
5. Paid or incurred during the taxable year
6. Expenses must not be against public policy, public moral
or law
7. If subject to withholding tax, proof of payment to BIR Expense must be substantiated by proof
must be shown GR: No deduction from gross income shall be allowed unless the
taxpayer substantiate with sufficient evidence

Expense must be ordinary and necessary XPN: Cohan Rule Principle

Ordinary – common to incur in the trade or business of the taxpayer Allows taxpayers to deduct some of their business-related
as distinguished from capital expenditures. expenses even if the receipts have been lost or misplaced so long as
they are reasonable and credible
Burden of Proof: taxpayer – receipts are the best proof
Best Evidence Obtainable Rule: when a report required by law as a
basis for the assessment of any national internal revenue tax shall
not be forthcoming within the time fixed by laws or rules and
regulation or when there is a reason to believe that any such report
is a false, incomplete or erroneous—Commissioner shall asses the
proper tax on the best evidence obtainable.
Expense must be reasonable
Paid or incurred during the taxable year
Cash basis method - deducts expenses in the year in which they are
paid
Accrual basis method – recognizes expenses in the year they accrue
- Relies upon the taxpayer’s right to receive amounts or its
obligation to pay them, in opposition to actual receipt or
payment
All events test: requires that the liability be fixed and the amount of
such liability be determined with reasonable accuracy.
Requisites (the accrual of income and expense is permitted)
1. fixing of the right to income or liability to pay
2. the availability of the reasonable accurate
determination of such income or liability.
Expenses must not be against public policy, public moral or law
Any expense incurred for entertainment, amusement or
recreation that is contrary to law, morals, public policy or public
order shall in no case be allowed as a deduction [34 (a) (1) (a) (iv)]
- To permit a violator to gain a tax advantage through
deductions would in effect lessen the degree of punishment
intended or would frustrate the purpose and effectiveness
of the public policy that has been violated
If subject to withholding tax, proof of payment to BIR must be
shown
Any amount paid or payable which is otherwise deductible
from or taken into account in computing gross income or for which
depreciation or amortization may be allowed shall be allowed as
deduction only if it is shown that the tax required to be deducted
and withheld therefrom has been paid to the BIR.
Requisites on deductibility of compensation for personal services:
a. Reasonable
b. Payments for personal services actually rendered
c. Compensation is for such services rendered
If the compensation is a fringe benefits, the fringe benefit
tax must have been paid.
Rules on the deductibility of the bonuses to employees:
a. Payment of the bonuses is in fact compensation
b. Must be for personal services actually rendered
c. The bonuses, when added to the salaries are reasonable,
when measured by the amount and quality of the services
 performed with relation to the business of the particular
taxpayer
Bonuses are deductible under the following:
a. Paid in good faith as additional compensation for services
rendered
b. Reasonable amount. – To hold otherwise would open the
gate to rampant tax evasion
c. Not to exceed reasonable compensation when added to
stipulated salaries.
Suggested tests:
- Good faith
- Character of business
- Salary policy of the corporation
- Type and extent of services
- Employee’s qualification and contribution
- General economic conditions
Travelling expenses – include transportation expenses and meals
and lodging
Requisites:
A. Paid or incurred while “away from home”
a. Transportation expenses from main office to
branch, from branch office to main office –
deductible
b. Transpo expenses from office to home; home to
office – not deductible
c. If a company car is utilized both for business and
personal use – proportion to the use
B. Paid or incurred in the conduct of trade or business
C. Reasonable and necessary expenses
Rent Expense –
Operating Lease – a lease in which all risks and rewards related
to asset ownership remain with the lessor.
Finance Lease (capital lease) – the risks and rewards related to
asset ownership are transferred to the lessee.
Annual Deduction = Cost of the building
Lease Term or Useful Life, whichever is shorter
Representation and Entertainment Expenses
Representation expenses – expenses incurred by a taxpayer in
connection with the conduct of his trade, business or exercise of
profession, in entertaining, providing amusement and
recreation to guests.
Entertainment Facilities – yacht, vacation home/condominium;
and any similar item of real or personal property used by the
taxpayer
Requisites for deductibility:
1. Subject to the rule of substantiation (receipt or adequate
records, amounts of expense, purpose and professional or
business relationship of expense
2. Paid or incurred in the pursuit of trade or business
3. Paid or incurred in the taxable year
4. Not contrary to law, morals and public policy
 5. reasonable

Interest Expenses – amount which one has contracted to pay for

the use of borrowed money or amount of compensation paid for
the use of money or forbearance from such use

Theoretical Interest: interest calculated or computed for

the purpose of determining the “opportunity cost” of
investing funds in a given business. – not deductible