Unit 10: Income and Business Taxation

Lesson 10.2
Introduction to Taxation
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Principles of Taxation 4
Principle of Reciprocity 4
Power of Taxation 4
Purpose of Taxation 5
Primary 5
Secondary 5
Individuals Earning Purely from Compensation Income 6
Gross Salary 7
Mandatory Contributions 7
Tax Due 8
Reporting Obligations 9
Individuals Earning Business Income and/or Professional Income 13
Tax Due 13
Corporations 16
Taxable Income 16
Classification of Corporations 17
Tax Due from a Corporation 17
Case Study 20
Keep in Mind 21
Try This 22
Practice Your Skills 23
Challenge Yourself 25
Photo Credit 25
Bibliography 26
Unit 10: Income and Business Taxation

Lesson 10.2

Introduction to Taxation

Introduction

You might observe that professionals and businesses are busy on particular dates of the year
when tax deadlines are coming. Their respective staff review all financial data and prepare
the BIR forms for submission. For taxpayers, it is imperative to pay the correct amount of tax
on time.

Over the past years, there has been an increase in freelancer professionals and sole
proprietorship businesses. Most of these individuals are former employees in the public and
private sectors who decided to change their sources of income. As a result, most of them are
unfamiliar with filing, paying, and reporting income and business taxes.

Thus, the Bureau of Internal Revenue holds special seminars for these professionals and
business owners to provide them with the basic knowledge on filing taxes and ensure that

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they abide by the tax laws and regulations.

Learning Objectives DepEd Competencies

At the end of this lesson, you should be able to ● Explain the procedure in the computation
do the following: of gross taxable income and tax due
(ABM_FABM12-IIh-j-17).
● Explain the principles of taxation.
● Prepare the BIR forms.
● Compute the taxable income and tax (ABM_FABM12-IIh-j-18).
● Explain the principles and purposes of
due using different tax rates.
taxation.
● Distinguish taxation on individuals and (ABM_FABM12-IIh-j-19).

businesses. ● Distinguish individual from business

taxation.
(ABM_FABM12-IIh-j-20).
● Compute the gross taxable income and
tax due
(ABM_FABM12-IIh-j-21).

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Quick Look

Just and Fair System of Taxation

The taxation system should be carefully structured in a fair and just way, considering the
common circumstances of different taxpayers. This way, taxpayers do not feel burdened,
and they feel that they are more willing to contribute to the government.

Questions to Ponder
1. How does income taxation affect the progress of the nation?

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

2. Is it beneficial to an individual or business to pay taxes? Why?

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

3. Why do some individuals hesitate to pay taxes?

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

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Unit 10: Income and Business Taxation

Learn the Basics

In the previous lesson, you learned some of the basic taxation concepts, including gross
income, allowable deductions, and taxable income. When asked to calculate the taxable
income, there are two things to remember: (1) ensure that all receipts subject to basic
income tax are included in your total gross compensation, business or professional income,
and (2) ensure that you only include those items allowed by the Tax Code as deductions.

This lesson's primary focus will be learning how to calculate taxable income. However, before
we go right into that, we will first review the purpose and underlying principles of taxation.

Essential Question

Are the current tax laws fair and just?

Principles of Taxation
Different principles underlie the taxation system. These principles are the foundation for
creating tax laws and regulations. You must know these principles to understand the basis of
specific tax provisions, including those relevant in the computation of taxable income and tax
due.

Principle of Reciprocity
The integration of taxation in every country has worked because of the Principle of
Reciprocity. This principle embodies the idea of "give and take." Simply put, if the
government takes a portion of its citizens' hard-earned money, then it should give back to its
citizens through social services, infrastructure development, and social development.

Power of Taxation
Taxation is one of the inherent powers of the government, and its scope is quite broad
because it is considered the lifeblood of the government.

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The main characteristics of the power of taxation are outlined below.

1. Taxation is comprehensive. Taxes are not only imposed on the income of individuals
and businesses, but they can also be imposed on activities, rights, and privileges.
2. In general, the subject of taxation is unlimited. It means that there is no limit to
what items can be subjected to tax as long as there is no enacted law stating
otherwise.
3. The tax imposed is plenary. Since it is plenary, the BIR may avail remedies that
would help ensure the collection of taxes.
4. Taxation is supreme. It means that in the absence of expressed law stating
otherwise, the principles of taxation shall prevail, and the state and its citizens shall
prioritize its purpose over anything else.

Check Your Progress

Why is reciprocity a consideration in Philippine taxation?

_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________

Purpose of Taxation
Understanding the purpose of taxation can help you appreciate everything that you will learn
in this lesson. This section discusses the different purposes of taxation, which are classified
into: Primary and Secondary.

Primary
The primary purpose of taxation is to provide funds to the government which must be used
for public purposes (e.g., promotion of public welfare, protection from harm and threats,
etc.).

Secondary
The secondary purposes of taxation are the following:
1. For regulation: taxation is also used to regulate certain activities and businesses in
the country. The best example of this would be the imposition of excise taxes. As

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discussed in the previous lesson, excise taxes are imposed to limit the purchase of
products that are considered harmful, especially when consumed excessively.
2. For social or economic benefits: the taxation system provides certain social and
economic benefits such as:
● Reduction of social inequality – Taxpayers are taxed according to their
capability to pay. Hence, wealthier individuals pay higher taxes, while some do
not have to pay certain taxes, such as minimum wage earners. Tax incentive
systems are also in place to provide tax exemptions for priority industries and
sectors. Such policies are meant to support their growth.
● Economic growth – Government spending on public infrastructures helps
slow inflation.

Taxation on Taxpayers
Individual taxpayers are categorized into groups according to their source/s of income. The
government mandates the allowable deductions and the tax rate applicable per group.
These details are necessary for the computation of the taxable income. The general
classification of taxpayers is shown in Figure 1.

Figure 1. Classification of taxpayers

Individuals Earning Purely from Compensation Income

Taxpayers whose only source of income comes from wage or salary are considered
Individuals Earning Purely from Compensation Income. Calculating their taxable income is
the simplest compared to other classifications of taxpayers. Their taxable income is
calculated using the following formula:

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Gross Salary
The gross salary of an employee should include the following:
● Basic salary
● Taxable allowances
● Bonuses
● Overtime pay/Night Shift Differential pay/Holiday pay

Mandatory Contributions
The only deductions allowed on their gross income are the mandatory government
contributions. These contributions are payments made on government-mandated benefits.
Only employees earning more than P1,000 per month must pay these mandatory
government contributions, which are:

1. Social Security System (SSS) contributions – The total contribution required is

determined by the SSS contribution schedule applicable for the taxable year. This
information is accessible on the government body's official website.

As of the year 2022, the required total contribution to SSS is 13% of the employee's
monthly salary credit as seen in the SSS contribution table.

The obligation to pay the total amount of SSS contribution is shared between the
employer and the employee as follows:
● Employee's share (EE) - 4.5% of the employee's monthly salary credit
● Employer's share (ER) - 8.5% of the employee's monthly salary credit

2. Philhealth contributions – The contributions you make to Philhealth enable the

agency to provide health benefits and assistance to its members. The required
contribution amount to Philhealth is calculated based on the premium rate applicable
for the taxable year. Remember to check that you are using the correct premium rate,
as the premium rate changes and increases annually. The obligation to pay the total
contribution to Philhealth is shared equally between the employer and the employee.

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3. Pag-IBIG contribution – Contributions made to Pag-IBIG are utilized mainly for

housing assistance. Currently, the total contribution to Pag-IBIG is only ₱200, to which
the obligation to pay is split equally between the employer and the employee.

Only the employee's share in all of these mandatory government contributions should be
deducted from an employee's salary when computing for his/her taxable income. However,
in practice, employers use payroll software and applications which automatically calculate
these contributions so employees do not need to manually calculate these.

Tax Due
The tax due for this type of taxpayer is calculated using the Schedule of Tax Rates for
Individuals (also commonly referred to as Graduated Rates). The Schedule of Tax Rates for
Individuals that is applicable for January 1, 2018 to December 31, 2022 is provided below:

Table 1. Graduated Rates applicable for January 1, 2018 to December 31, 2022.

Amount of Taxable Income

Tax Due
Over But not Over

- ₱250,000 Nil

₱250,000 ₱400,000 20% of the excess over ₱250,000

₱400,000 ₱800,000 ₱30,000 PLUS 25% of the excess over ₱400,000

₱800,000 ₱2,000,000 ₱130,000 PLUS 30% of the excess over ₱800,000

₱2,000,000 ₱8,000,000 ₱490,000 PLUS 32% of the excess over ₱2,000,000

Above ₱8,000,000 ₱2,410,000 PLUS 35% of the excess over ₱8,000,000

The tax due from an individual earning purely from compensation income is withheld by
his/her employer every payroll period. It means that the employer has the primary obligation
to remit the tax due from the employee to the BIR.

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Closer Look

Individuals Earning Purely from Compensation Income

Linda, who is currently employed as a cook, earned ₱420,000 as gross
salary in 2022. Based on this information, her employee contributions
should be as follows:

SSS employee contribution: ₱13,500

Philhealth employee contribution: ₱8,400
Pag-ibig employee contribution: ₱1,200

1. How much is Linda’s taxable income?

Taxable Income = Gross Income – Government-Mandated
Contributions
₱396,900 = 420,000 – ( 13,500 + 8,400 + 1,200 )

2. How much is the tax due from Linda?

Tax Due = Taxable Income x Tax Rate
₱29,380 = ( 396,900 – 250,000 ) x 20%

3. How much is Linda’s net pay?

Net Pay = Gross Income - Government-Mandated Contribution -
Tax Due
₱367,520 = 420,000 – (13,500 + 8,400 + 1,200) – (29,380)

Reporting Obligations
The reporting obligation of an individual who is earning purely compensation income
depends on whether he/she had more than one employer during the taxable year or not.
The table summarizes the BIR forms required per scenario.

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Table 2. Reporting obligations of individuals earning purely compensation income

Scenario Obligation of the Employer Obligation of the Employee

Only 1 employer BIR Form 2316 Not applicable

More than 1 employer BIR Form 2316 BIR Form 1700

Examine the look and contents of the BIR Form 2316.

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Figure 2. BIR Form 2316

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The numbers beside each field of the Form 2316 are discussed briefly below.
1. Indicate the tax period. Item 2 should be in a Month/Day format.
2. Provide the employee’s information (e.g., TIN, name, address, birthdate,). There is no
need to fill out information relating to items 9 and 10 if the employee is not a
minimum wage earner.
3. Provide the information of the taxpayer’s present and previous employer (e.g., TIN,
name, address).
4. This part itemizes all non-taxable compensation income received by the employee.
5. This part itemizes all taxable compensation income received by the employee.
6. This part summarizes the employee’s taxable compensation income, non-taxable
compensation, taxable income, tax due, and taxes withheld for the tax period.
7. The employee and the employer will have to signify that the information provided in
the form is complete and correct.
8. The employee and the employer will have to signify that the employee is qualified for
substituted filing (if applicable).

In practice, the information needed to fill out parts 3, 4, and 6 are already summarized in the
payroll software used by the employer and the information simply needs to be carefully
copied to the form.

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Check Your Progress

What is the importance of using various forms in filing for income tax?
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________

Individuals Earning Business Income and/or Professional Income

Income is earned not only by means of employment. A person can earn income by
establishing and managing a business either as a sole trader or a partner. You may also
practice your profession without the need of an employer. How are these people being
taxed, and how do you compute the taxable income?

Tax Due
The income tax due from this type of taxpayer is calculated based either on the Graduated
Tax Rates or the 8% tax on gross sales.

The Graduated Income Tax Rate uses the following computation in determining the taxable
income.

Gross Business Income / Gross Professional Income XXX

Less: Allowable Deductions (Itemized or Optional) (XXX)

Taxable Income XXX

Once the taxable income is determined, the taxpayer should refer to the schedule of tax
rates for individuals (refer to Table 1) to determine the tax due.

The 8% Income Tax Rate has a different computation for taxable income. Under this option,
the only allowable deduction on gross business income is ₱250,000. Thus, the taxable
income under the 8% tax is:

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Once the taxable income is determined, the tax due will be calculated using the following
formula:

Note that the following do not have the option to use the 8% tax rate:
● A taxpayer that is VAT registered (regardless of gross sales/receipts)
● A taxpayer who has gross receipts or sales exceeding the VAT threshold1
● A taxpayer whose income is required to be subjected to Other Percentage Taxes
● A partner who receives a share of income from a General Professional Partnership.
Such a partner is not qualified under the 8% tax rate because the share of income
he/she receives is already net of allowable deductions from that partnership.

Closer Look

Individuals Earning Business Income

Karine, a sole trader, is deciding whether to choose the Graduated
Income Tax Rate or the 8% Income Tax Rate. She asked for your help and
provided you with the relevant financial data in a quarter.

Gross Sales: ₱450,000

Total Expenses: ₱125,000

Computation Under the 8% Income Tax Rate

How much is her taxable income and tax due under the 8% Income Tax
Rate?

Taxable income (8% Rate) = Gross Sales – 250,000

= 450,000 – 250,000
= ₱200,000

1
VAT Threshold — indicates the maximum gross receipts/sales that a business can earn before it will be required to
register for VAT (currently at P3,000,000)

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Tax Due (8% Rate) = Taxable Income x 0.08

= 200,000 x 0.08
= ₱16,000

Computation Under the Graduated Income Tax Rate (Itemized)

How much is her taxable income and tax due under the Graduated
Income Tax Rate (Itemized Deduction)?

Taxable Income under the Graduated Tax Rate (Itemized Deduction) =

Gross Sales – Total expenses
= 450,000 – 125,000
= ₱325,000

Tax Due (Graduated, Itemized) = 20% of excess over 250,000

= (325,000 – 250,000) x 0.20
= 75,000 x 0.20
= ₱15,000

Computation Under the Graduated Income Tax Rate (Optional)

How much is her taxable income and tax due under the Graduated
Income Tax Rate (Optional deduction)?

Taxable income under the Graduated Tax Rate (Optional Deduction) =

Gross Sales – (40% of gross sales)
= 450,000 – (450,000 x 0.40)
= 450,000 – 180,000
= ₱270,000

Tax Due (Graduated, Optional) = 20% of excess over 250,000

= 270,000 – 250,000
= 20,000 x 0.20
= ₱4,000

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Unit 10: Income and Business Taxation

Corporations
The definition of corporations per the Corporation Code of the Philippines is quite different
from how corporations are defined in the context of Philippine taxation.

Table 3. Definitions of corporations according to the Corporation Code and the Tax Code

Definition per Corporation Code Definition per Tax Code

“A corporation is an artificial being created
by operations of law having the right of
succession and the powers, attributes, and
properties expressly authorized by law or
incident to its existence”
“The term 'corporation' shall include one
person corporations [10], partnerships, no
matter how created or organized,
joint-stock companies, joint accounts
(cuentas en participación), associations, or
insurance companies, but does not include
general professional partnerships and a
joint venture or consortium formed for the
purpose of undertaking construction
projects or engaging in petroleum, coal,
geothermal and other energy operations
pursuant to an operating consortium
agreement under a service contract with
the Government.“

Under the CREATE law, a One Person Corporation (OPC) shall be taxed as a corporation
despite its structure of having only one stockholder, provided that such corporation was
formed by a natural person, a trust, or through an estate.

Taxable Income
The general principles discussed previously about gross income and allowable deductions
also apply when calculating the taxable income of a corporation. Similarly, a corporation's
taxable income will be calculated as:

Gross Business Income XXX

Less: Allowable Deductions (Itemized or Optional) (XXX)

Taxable Income XXX

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Classification of Corporations
For income tax purposes, corporations are classified into:

Domestic Corporations (DC) are corporations created or organized under Philippine laws.

Resident Foreign Corporation (RFC) is a corporation that is:

● Not a domestic corporation; and
● Engaged in trade or business in the Philippines.

Non-resident Foreign Corporation (NRFC) is a corporation that is:

● Not a domestic corporation; and
● Not engaged in trade or business in the Philippines.

The gross income that will be subjected to Philippine taxation depends on the corporation's
classification as shown in the table below.

Table 4. Income of corporations subject to Philippine taxation

DC RFC NRFC

Within and Outside the Within the Philippines Within the Philippines
Philippines

Tax Due from a Corporation

The tax due from a corporation should be whichever is higher between the Minimum
Income Tax (MCIT) or Normal Corporate Income Tax (NCIT).

Minimum Income Tax (MCIT)

The government states that every corporation should have a minimum contribution to the
government, which is commonly referred to as the Minimum Corporate Income Tax. MCIT is
computed using the following formula:

The consideration of MCIT only arises upon the fourth taxable year counting from the
commencement of the corporation. It does not automatically start upon opening because it

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is not practical to immediately require corporations to pay a minimum contribution when

starting their business.

The requirement to calculate for MCIT does not apply to NRFCs. It means that if an NRFC is
operating in a net loss or has a nil taxable income for the taxable year, it will have nil tax due.

Rates on Normal Corporate Income Tax (NCIT)

Normal Corporate Income Tax (NCIT) is the tax due to a corporation using the basic rates
applicable to a corporation for that taxable year. It is computed using the following formula:

Table 5. Applicable tax rates when computing for NCIT effective July 1, 2020.

Corporation Rate on NCIT

DC whose: 20%
● taxable income is P5 million and below; AND
● total assets are P100 million and below

DC whose: 25%
● taxable income is above P5 million; AND
● total assets are above P100 million.

RFC 25%

NRFC 25%

Excess MCIT
For every taxable period, you will have to compute the excess between MCIT and NCIT. Any
excess MCIT can be carried forward for the next three taxable years but can only be
creditable against your tax due if your NCIT for that year is higher than MCIT.

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Closer Look

Tax Due from Corporations

Assume the following information for ABC Corporation. ABC Corporation
is a domestic corporation in its 7th year of business operations.

2021 2022 2023

Gross Income, Ph ₱575,000 ₱100,000 ₱200,000

Expense, Ph (105,000) (150,000) (140,000)

Gross Income, Au 50,000 ₱20,000 ₱50,000

Expense, Au (10,000) (15,000) (10,000)

Determine ABC corporation’s taxable income for the year 2021.

₱510,000 = (575,000 + 50,000) - (105,000 + 10,000)

Determine the tax due from ABC corporation for the year 2021.
₱102,000 (Higher between NCIT and MCIT)
NCIT: 510,000 x 20% = 102,000
MCIT: (575,000 + 50,000) x 1% = 6,250

Determine the tax due from ABC corporation for the year 2022.
₱1,200 (Higher between NCIT and MCIT)
NCIT: (45,000) x 20% = (9,000)
MCIT: (100,000 + 20,000) x 1% = 1,200

Determine the tax due from ABC corporation for the year 2023.
₱20,000 (Higher between NCIT and MCIT)
NCIT: 100,000 x 20% = 20,000
MCIT: (200,000 + 50,000) x 1% = 2,500

Determine the tax payable from ABC corporation for the year 2023.
₱9,800 = 20,000 - 10,200*

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*Excess MCIT from 2022 is deducted from your tax due because
NCIT was greater than MCIT in 2023: 1,200 – (9,000) = 10,200

Case Study

Overview of Philippine Taxation

The Philippine’s priority investment areas in 2020 are:
● manufacturing activities, including agro-processing;
● agriculture, fishery, and forestry;
● strategic services;
● healthcare and disaster risk reduction management services;
● mass housing;
● infrastructure and logistics, including LGU-PPPs;
● innovation drivers;
● inclusive business models;
● environment and climate change-related projects; and
● energy.
The government continues to provide tax incentives to investors in the
Philippines in these priority areas.

Filipino Gross Domestic Product (GDP) recorded a 7.1% growth rate in the
third quarter of 2021. The main growth drivers with corresponding
increases are Car and motorcycle repairs 6.4%. Manufacturing, 6.3
percent. Furthermore, it was built at 16.8 percent. Manufacturing and
services recorded positive growth of 7.9% and 8.2% among the major
economic sectors. Meanwhile, Agriculture, Forestry and Fisheries (AFF)
recorded a -1.7% reduction in the third quarter.

Philippines Overview
“Philippines.” Overview. Accessed June 29, 2022.
https://taxsummaries.pwc.com/philippines.

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Keep in Mind

● Taxation is guided by two fundamental principles: the principle of reciprocity and the
power of taxation. These two principles simply state that governments are given the
power to impose taxes so that they can give it back to their citizens in the form of
services, infrastructure, and development.
● Taxes are collected to raise government funds, regulate spending, and attain social and
economic benefits.
● There are three categories of taxpayers, and specific tax laws and regulations govern
each.

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Try This

True or False. Write true if the statement is correct. Otherwise, write false.

________________ 1. Different principles underlie the system of taxation.

________________ 2. Taxation is not an inherent power of the government.

________________ 3. Taxes are not only imposed on the income of individuals and
businesses.

________________ 4. In general, the subject of taxation is unlimited.

________________ 5. In the absence of expressed law stating otherwise, the

principles of taxation shall prevail.

________________ 6. The secondary purpose of taxation is to provide funds to the

government.

________________ 7. A secondary purpose of taxation is to regulate certain

activities and businesses.

________________ 8. Gross salary includes basic pay.

________________ 9. SSS is not a mandatory government contribution.

________________ 10. Pag-IBIG contributions are utilized mainly for housing

assistance.

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Practice Your Skills

How Much is the Tax Due?

Read the following situations and calculate the taxable income and tax due.

1. Carol is an employee of ABC Corporation. Her annual gross income is ₱420,000. Her
compensation package includes all government-mandated benefits. Assume that the
total employeecontributions are the following:
SSS: ₱13,500
PhilHealth: ₱8,400
Pag-IBIG: ₱1,200

How much is Carol’s taxable income, and how much is her tax due?

2. Ely is a freelance marketing professional. His quarterly gross income is ₱350,000.

Suppose that he opted for optional deduction and graduated rates. How much is his
taxable income and tax due?

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3. Suppose Ely decided to use the 8% Income Tax Rate option. How much is his tax due?

4. Kristine’s business, which is a domestic corporation, has the following financial data
for three years.

2022 2023 2024

Gross Income, Ph 740,580 85,390 232,466

Gross Income, Au 50,000 20,000 50,000

Expense, Ph 100,000 140,000 120,000

Expense, Au 15,000 25,000 30,000

Calculate the MCIT for 2022.

5. Calculate the NCIT for 2023.

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Challenge Yourself

Answer the following questions:

1. What is the significance of having different tax computation options for Individuals
Earning Business Income and/or Professional Income?
__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

2. What are the similarities and differences in the computation of taxable income and
tax due for individuals and businesses?
__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

3. An individual earning business income opted for an income tax rate with the least
amount of tax due. Is this good or bad? Justify your answer.
__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Photo Credit
Gross Income by Nick Youngson is licensed under CC-BY SA 3.0 via Pix4free.org.

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Bibliography
Banggawan, R. Income Taxation: Laws, Principles, and Applications. Baguio City: Rex Excellence
Publishing, 2019.

Garcia, E.R. and Tabag, E.D. Income Taxation with Special and Properly Filled BIR Forms.
Quezon City: EDT Bookshop, 2020.

Garcia, E.R. and Tabag, E.D. Transfer & Business Taxation with Special Topics and Properly Filled
BIR Forms. Quezon City: EDT Bookshop, 2020.

“Income Tax.” Bureau of Internal Revenue.” Last accessed June 30, 2022.
https://www.bir.gov.ph/index.php/tax-information/income-tax.html

“Philippines.” Individual - Taxes on personal income. Last modified July 5, 2022.

https://taxsummaries.pwc.com/philippines/individual/taxes-on-personal-income.

10.2. Introduction to Taxation 26