REGULAR INCOME TAXATION

-Exclusions and Inclusions in Gross Income

Objectives:
 To demonstrate mastery on the list of exclusions and inclusions in gross income
 To demonstrate comprehension of exclusion conditions or limitations of certain items of
income
 To demonstrate knowledge of the list of entities exempt under the NIRC and special laws
 To demonstrate knowledge on the boundary between income subject to final tax or capital
gains tax and those subject to regular income tax, and of the link between items of exempt
income and income subject to regular income tax

Introduction
This part of the module discusses the items of income that are excluded and included in gross income.
You should have a deep understanding on the list of income subject to final tax or capital gains tax to
enable you to set boundary between those items and those subject to regular tax.
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You received a gift from your friend amounting to P10,000, is it taxable?

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EXCLUSIONS FROM GROSS INCOME

Exclusions from gross income are income which will not be subject to income tax. They are not
included in gross income subject to regular tax, capital gains tax, or final tax.
Under Sec. 32 (B) of the NIRC, the following items shall not be included in gross income and shall be
exempt from taxation:
A. Proceeds of life insurance policy
B. Amount received by the insured as a return of premium
C. Gift, bequest, devise, or descent
D. Compensation for injuries or sickness
E. Income exempt under treaty
F. Retirement benefits, pensions, gratuities, etc.
G. Miscellaneous items
1. Income in the Philippines of foreign government or foreign government-owned and
controlled corporations.
2. Income of the government and its political subdivisions
3. Prizes and awards in recognition of religious, charitable, scientific, educational, artistic,
literary, or civic achievements.
4. Prizes and awards in athletic sports competition.
5. Contributions to GSIS, SSS, Philhealth, Pag-Ibig, and union dues
6. Contributions to Personal Equity Requirement Account (PERA)
7. PERA investment income and PERA distributions
8. 13th month pay and other benefits not exceeding P90,000
9. Gains from sale of bonds, debentures, or certificates of indebtedness with maturity of more
than 5 years.
10. Gains from redemption of shares in mutual fund.

OTHER EXEMPT INCOME UNDER THE NIRC AND SPECIAL LAWS

1. Minimum wage and certain benefits of Minimum wage earners
2. Income of Barangay Micro-Business Enterprises Act (RA 9178)
3. Income of Cooperatives (RA 9520)
4. Income of non-stock, non-profit entities
5. Income of qualified employee trust funds
6. Business or professional income of self-employed and or professionals who opted to the
8% income tax.

INCOME OF SELF-EMPLOYED OR PROFESSIONALS WHO OPTED TO BE TAXED AT

8% INCOME TAX
The income of self-employed and or professionals who opted to be taxed to the 8% income tax shall
be excluded in gross income subject to regular tax. The 8% income tax is in lieu of the 3% percentage
tax and the progressive income tax.

INCOME SUBJECT TO FINAL TAX OR CAPITAL GAINS TAX

Items of income that are subject to final income tax or capital gains tax are not items of gross income
subject to regular income tax. Also, income items that are exempted in the coverage of final tax or
capital gains tax are not taxable to the regular income tax.
EXCLUSIONS VS. DEDUCTIONS
Exclusions from gross income are not included in the amount of reportable gross income in the
income tax return. The amount of deductions is initially included in the amount of gross income but is
separately presented as deduction against gross income in the income tax return.

INCLUSION IN GROSS INCOME

ITEMS OF GROSS INCOME
The term items of gross income or inclusions in gross income is a broad category pertaining to all
items of income subject to taxation, namely:
1. Gross income subject to final tax
2. Gross income subject to capital gains tax
3. Gross income subject to regular tax

ITEMS OF GROSS INCOME SUBJECT TO REGULAR TAX

Gross income includes, but is not limited to, the following items:
1. Compensation for services in whatever form paid
Under current tax rules, the term “compensation income" technically pertains to the types of
employee benefits that are subject to regular tax. The fringe benefits of managerial or
supervisory employees are not considered compensation income and are subject to final tax.

2. Gross income from the conduct of trade, business, or exercise of a profession

This includes income from any trade or business, legal or illegal, and whether registered or
unregistered. Gross income from business or profession is determined as follows:
Sales/Revenues/ Receipts/ Fees P xxx,xxx
Less: Cost of sales or services xxx,xxx
Gross income from operations P xxx,xxx

The following business income shall not be included in gross income subject to regular
income tax:
1. Business income exempt from income tax
2. Business income subject to special tax regime
3. Business income subject to final tax

3. Gains derived from dealings in properties

The gains or losses in dealing in ordinary assets are subject to regular income tax. Dealings in
capital assets other than domestic stocks and real properties are also subject to regular income
tax.
4. Interest
This particularly refers to interest income other than passive interest income subject to final
tax. A taxable interest income must have been actually paid out of an agreement to pay
interest. It cannot be imputed. (CIR vs. Filinvest Development Corporation, GR 163653 and
167689)

5. Rents
Rent income arises from leasing properties of any kind. It is a passive income but is not
subject to final tax under the NIRC: hence, it is subject to regular income tax.

Special considerations on rent

1. Obligations of the lessor that are assumed by the lessee are additional rental income to the
lessor.
2. Advance rentals are
a. Item of gross income upon receipt if:
i. Unrestricted or
ii. Restricted to be applied in future years or upon the termination of the lease
b. Not an item of gross income if:
i. It constitutes a loan
ii. It is a security deposit to guarantee payment or rent subject to contingency
which may or may not happen.
3. Leasehold improvements made by the lessee on the leased property are recognized by the
lessor as income using the spread-out method or outright method.

6. Royalties
Royalties earned from sources within the Philippines are generally subject to final come tax
except when they are active by nature. Active royalty income and royalties earned from
sources outside the Philippines are subject to regular income

7. Dividends
These pertains to dividends declared by foreign corporation

8. Annuities
The excess of annuity payments received by the recipient over premium paid is taxable
income in the year of receipt.
9. Prizes and Winnings
Prizes and winnings that are exempted from final tax are not items of gross income subject to
regular income tax.
Exempt prizes and winnings:
1. Prizes received without effort to join a contest
2. Prizes in athletic competitions sanctioned by their respective national sports association
3. Winnings from PCSO or lotto, not exceeding P20,000 in amount

10. Pensions
These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and
hence subject to regular tax.

11. Partner’s distributive share from the net income of general professional partnership
It should be recalled that general professional partnerships are not subject to income tax (i.e.,
final tax, capital gains tax or regular income tax) because they are merely viewed as pass-
through entities. The partners are the ones subject to regular tax on their share in the net
income of the general profession partnership.

For this purpose, the net income of the general professional partnership include items of
income which are exempted from final tax or capital gains tax to the general professional
partnership.

GENERAL CRITERIA FOR ITEMS OF GROSS INCOME

Items of gross income subject to regular income tax are not limited to the aforementioned NIRC list.
Under the NIRC, the regular income tax has a catch-all provision for all income derived from
whatever sources that are:
1. not subject to final tax, capital gains tax, and special tax regime, and
2. not excluded or exempted by law, treaty, or contract from taxation.

OTHER SOURCES OF GROSS INCOME SUBJECT TO REGULAR INCOME TAX

1. Income distributions from taxable estates or trusts
2. Share from the net income of other pass-through entities:
a. Exempt joint venture
b. Exempt co-ownership
3. Farming income
4. Recovery of past deductions
5. Reimbursement of expenses
6. Cancellation of indebtedness for a consideration

SPECIAL CONSIDERATIONS IN REPORTING OF GROSS INCOME

1. Accounting methods
2. Situs rules
3. Effect of value added tax
4. Creditable withholding tax
5. Power of the CIR to redistribute income and expenses

COMPENSATION INCOME

EMPLOYER-EMPLOYEE RELATIONSHIP

Employer - refers to any person for whom an individual performs any service of whatever nature as
employee of such person.

An employer is the person who has control over the payment of the employee i remuneration.
However, if such person is a non-resident not engaged in trade or a business in the Philippines, the
employer is deemed the person paying remuneration in their behalf.

Employee — refers to any individual who is a recipient of wages and includes Officer, employee or
elected official of the Government of the Philippines or any 13 {political subdivisions, agency or
instrumentality thereof. The term also includes an officer of a corporation.

TYPES OF EMPLOYEES AS TO FUNCTION

1. Managerial employees — Those who are given powers or prerogatives to lay down and execute
managerial policies and/or to hire, transfer, suspend, lay- off, recall, discharge, assign or discipline
employees
2. Supervisory employees — Those who effectively recommend such managerial actions if the
exercise of such authority is not merely routinary or clerical in nature but requires the use of
independent judgment.
3. Rank and file employees - Those who hold neither managerial nor supervisory functions.

TYPES OF EMPLOYEES AS TO TAXABILITY

1. Minimum wage earners - Employees who are recipients of minimum wage. They are exempt from
income tax on their compensation.
2. Regular employees - Employees who are subject to the regular progressive income tax

THE TAX MODEL ON COMPENSATION INCOME

Gross compensation income P xxx,xxx
Less: Non-taxable compensation xxx,xxx
Taxable compensation income P xxx,xxx

GROSS COMPENSATION INCOME

Gross compensation income generally includes all remunerations received under an employer-
employee relationship.

NON-TAXABLE COMPENSATION
A. Mandatory deductions
These includes employees' mandatory contribution to GSIS, SSS, PhilHealth, HDMF, and
union dues

B. Exempt benefits
1. Benefits excluded and/or exempted under the NIRC and special laws
2. Benefits exempt under treaty or international agreements
3. Benefits necessary to the trade, business, or conduct of profession of the employer
4. Benefits for the convenience or advantage of the employer

EXEMPT BENEFITS UNDER THE NIRC, AS AMENDED, AND SPECIAL LAWS

1. Remunerations received as incidents of employment
a. Exempt retirement benefits under RA 7641 including exempt retirement gratuities to
government officials and employees
b. Exempt termination benefits
c. Benefits from the United States Veterans Administration
d. Social security, retirement gratuities, pensions, and similar benefits from foreign
government agencies and other institutions, private or public
e. Benefits from SSS, under the SSS Act of 1954, as amended
f. Benefits from GSIS under the GSIS Act of 1937, as amended
2. De minimis benefits
3. 13th month pay and other benefits not exceeding P90,000
4. Certain benefits of minimum wage earners
DE MINIMIS BENEFITS
De minimis benefits are facilities or privileges such as entertainment, medical services, or
courtesy discounts on purchases that are of relatively small value and are furnished by the
employer merely as a means of promoting the health, goodwill, contentment, or efficiency of
his employees. De minimis benefits are petty fringe benefits exempt from income tax.

The term “de minimis benefit” was restricted to mean only the following:

WHAT BENEFITS ARE CONSIDERED AS “DE MINIMIS” BENEFITS?

For tax purposes, only the benefits considered as “de minimis” are considered as tax-exempt. All
other benefits given by the employers which are not included in the listing of “de minimis benefits”
are not considered as “de minimis”, and hence, subject to income tax as well as withholding tax on
compensation income. Below is the list of the latest “de minimis benefits” of both managerial and
rank-and-file employees for income tax purposes. All allowances regularly received by the
employees are subject to income tax, except those that are enumerated below within the stated ceiling
amount.

1. Monetized unused vacation leave credits of employees not exceeding ten (10) days during the year;

2. Monetized value of vacation and sick leave credits paid to government officials and employees;

3. Medical cash allowance to dependents of employees, not exceeding P1,500 per employee per
semester or P375 per month;

4. Rice subsidy of P2,000 or one (1) sack of 50 kg. rice per month amounting to not more than
P2,000;

5. Uniform and Clothing allowance not exceeding P6,000 per annum;

6. Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs, annual
medical/executive check-up, maternity assistance, and routine consultations, not exceeding
P10,000.00 per annum;

7. Laundry allowance not exceeding P300 per month; (RR No. 5-2011)

8. Employee achievement awards, e.g., for length of service or safety achievement, which must be in
the form of a tangible personal property other than cash or gift certificate, with an annual monetary
value not exceeding P10,000 received by the employee under an established written plan which does
not discriminate in favor of highly paid employees; (RR No. 5-2011)
9. Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per
employee per annum;

10. Daily meal allowance for overtime work and night/graveyard shift not exceeding twenty-five
percent (25%) of the basic minimum wage on a per region basis;

11. Benefits received by an employee by virtue of a collective bargaining agreement (CBA) and
productivity incentive schemes provided that the total annual monetary value received from both CBA
and productivity incentive schemes combined do not exceed P10,000.00 per employee per taxable
year.

Taxable de minimis benefits

1. Excess de minimis over their regulatory limits
2. Other benefits of relatively small value that are not included in the list of de minimis benefits.

Treatment of taxable de minimis benefits

a. For rank and file employees- taxable de minimis is treated as other compensation income under the
category “13th month pay and other benefits”
b. For managerial and supervisory employees- taxable de minimis is treated as fringe benefit subject
final fringe benefit tax.

BENEFITS FOR THE CONVENIENCE OR ADVANTAGE OF THE EMPLOYER

These are benefits or allowances which are intended for the furtherance of the interest of the
employer’s business or to ensure its smooth operations are likewise exempt from income tax. This is
referred to as the “convenience of the employer rule”.

COMPOSITION OF TAXABLE INCOME

1. Regular compensation
This pertains to the fixed remunerations received by the employee every payroll period such
as
1. Basic salary
2. Fixed allowances
2. Supplemental compensation
This pertains to other performance-based pays to employees with or without regard to the
payroll period.
 The following are the additional compensation under current tax rules:
1. Overtime pay
2. Hazard pay
3. Night shift differential pay
4. Holiday pay
5. Commissions
6. Fees, including director’s fees (if director is an employee)
7. Emoluments and honoraria
8. Taxable retirement and separation pay
9. Value of living quarters or meals
10. Gains on exercise of stock options
11. Profit sharing and taxable bonuses

*13th month pay and other benefits not exceeding P90,000 is an exclusion from gross income. The
excess above P90,000 is added to supplemental compensation.

13TH MONTH PAY AND OTHER BENEFITS

1. 13th month pay
2. Other benefits
a. Christmas bonus of private employees
b. Cash gifts other Christmas or anniversary gifts of private employees
c. Additional compensation allowance (ACA) of government personnel
d. 14th month pay, 15th month pay, etc.
e. Other fringe benefits of rank and file employees
13th Month pay
a. The 13th month pay of government employees consists of Christmas bonus equivalent to one-month
salary plus a P5,000 cash gift.
b. The 13th month pay of private employees is equivalent to one-month salary.

TAX TREATMENT OF 13TH MONTH PAY AND OTHER BENEFITS

RR2-98 provides that 13th month pay and other benefits are exempt from withholding on
compensation provided they do not exceed P90,000. It follows, therefore, that he excess above
P90,000 is subject to the withholding tax on compensation.
DEADLINE OF FILING AND REMITTANCE OF THE WITHHOLDING TAX ON
COMPENSATION

Employers shall file the BIR Form 1601C (Monthly Remittance Return of Income Taxes Withheld on
Compensation) on or before the 10th day of the following month the withholding was made except for
taxes withheld for December which shall be filed/paid on or before January 15 of the succeeding year.

Employers are also required to file BIR Form 1604-CF (Annual Information Return of Income Taxes
Withheld on Compensation and Final Withholding Taxes) on or before January 31 of the following
calendar year in which the compensation income payments and passive income payments were made.

Employers shall furnish each employee-taxpayer a copy of BIR Form 2316 (Certificate of
Compensation Payment or Income Tax Withheld) on or before January 31 of the succeeding year.

Penalties for Non-compliance

Employers are subject to the same penalties for non-compliance of withholding tax requirements.

Treatment of the Withholding Tax on Compensation

If the employee has other items of income that are subject to regular income tax such as income from
business or profession, income from other employment or casual income, he must file a consolidated
income tax return to include such items of income for the entire taxable year. The withholding tax on
compensation is credited against the total tax due in the consolidated income tax return.

Substituted filing of tax return

Under the substituted filing system, the employer files the income tax return of the employee. If the
amount of tax is correctly withheld by the employer, the employee no longer needs to file an annual
income tax return.