Week 6 DEDUCTION FROM GROSS INCOME

1.1 Definition of Deduction

It refers to those business expenses and losses incurred which the law allows to
reduce gross business income to arrive at net income subject to tax.

1.2 Nature of Deduction

Deductions are strictly construed against the taxpayer. The taxpayer seeking a
deduction must be able to prove that he is entitled to the deduction which the law
allows.

The BIR issued regulation relative to the requirements for deductibility of certain
income payments. The salient features of the said regulation are:
1. No deduction shall be allowed on income payments if it is shown that the
applicable withholding taxes required by the rules had not been withheld.
2. No deduction will also be allowed if during tax assessment on deficiency
withholding taxes for alleged failure to withhold the taxpayer paid the
withholding taxes.

1.3 Items not Deductible from Gross Income

1. Personal, living or family expenses

2. Any amount paid out for new buildings or for permanent improvements or
betterments
3. Any amount expended in restoring property for which an allowance is or has
been made
4. Premiums paid on any life insurance policy covering the life of any officer or
employee
5. Transactions between related taxpayers resulting to losses from sales or
exchanges of property, interest expense or bad debts
6. Bribes, kickbacks and other similar payments
7. Donations made to employees and others
8. The amount spent for political campaign, campaign funds and donations to
political parties or candidates
1.4 Classifications of Deductions from Gross Income

1. Optional standard deduction (OSD)

- For individual, the OSD is 40% of his gross sales or receipts.
- For corporation, the OSD is 40% of its gross income.
2. Regular allowable itemized deduction (refer to 1.5)
- Are ordinary and necessary business expenses paid or incurred during the
taxable year which require supporting documents to justify the reduction
from gross income
3. Special allowable itemized deduction

1.5 Regular Allowable Itemized Deductions

1. General business expenses

- Must be ordinary and necessary for conduct of business, substantiated
with receipts/ invoices, reasonable in amount, withheld with tax and paid
to BIR (if required), not contrary to law, morals, public policy or public
order, and incurred or paid and deducted within the taxable year
- May be in the form of:
a. Salaries and wages
b. Compensation for injuries and pensions
c. Materials and supplies
d. Traveling expenses
e. Rent expenses
f. Representation expenses (1/2% of net sales or 1% of net revenues)
2. Interest
3. Taxes
4. Losses
5. Bad debts
6. Depreciation or depletion
7. Charitable and other contributions
8. Research and development
9. Pension trust
10. Premium payments on health and/ or hospitalization insurance

1.6 Special Allowable Itemized Deductions

1. 50% special deduction for Adopt-A-School program

2. 15% additional deduction of salaries or wages paid to senior citizens
3. Senior citizen discount
4. Discounts to persons with disability
5. Net operating loss carry-over (NOLCO)
 Exercises

1. True or False
1. As a rule, deduction means itemized deduction.
2. Deductions from gross income are not presumed.
3. Business expenses are deductible only if these are incurred in relation to business
income taxable in the Philippines. False
4. No business and personal expenses are allowed as deductions from reportable
gross income. False
5. The optional standard deduction allowed to individual taxpayer is 40% based on his
gross income. False
6. NOLCO is among those that could be claimed as regular itemized deduction. False
7. A representation expense is subject to limit of 1% of net sales of goods. False
8. Donations to political parties or candidates are deductible from the gross income of
the taxpayer-donor. False
9. The adopt-a-school program is allowed to deduct 150% special deduction. False
10. Corporations are allowed to deduct optional standard deduction.

2. Multiple Choice
1. Which cannot be allowed as deductible in full from gross income?
a. Donations made to employees
b. Entire amount expended for meals, lodging, and travel in connection with own
business
c. Tuition fees, board and lodging incurred by a medical doctor while attending a
continuing professional education seminar
d. Cost of technical books used by a CPA in the practice of his profession

2. Which of the following expenses would be allowed as deduction from its business
income?
a. Insurance premium on life insurance of employee where the employer is the
beneficiary
b. Donation made to employees
c. Losses incurred on transaction with related party
d. Regular repairs of business property

3. Which of the following income is allowed to be reduced with itemized deductions?

a. Compensation income
b. Business income
c. Passive income
d. Capital gain

4. Which of the following will be an appropriate deductible expense for the exhaustion
of intangible asset of wasting asset corporation?
 a. Depreciation expense
b. Amortization expense
c. Depletion expense
d. Exploration expense

5. Which of the following taxes incurred in the conduct of business is allowed as

deduction from business income?
a. Income tax
b. Value-added tax
c. Community tax
d. Withholding tax on wages of employees

3. Problem Solving
1. The following business expenses and losses were submitted by Alce during the
taxable year:
Salary of employees P120,000
Police protection 20,000
Interest expense paid to his father 10,000
Gifts made to employees during birthday 5,000
Capital loss 4,000
Required:
How much is the amount of nondeductible expenses and losses?
Answer:
Police protection 20,000
Interest expense paid to his father 10,000
Gifts made to employees during birthday 5,000
Capital loss 4,000
Total 39,000

2. Ms. Jane showed the following income and expenses during the year:
Compensation income as a teacher P250,000
Sales of electronic business 300,000
Cost of sales 80,000
Operating expenses (without documentation) 50,000
Required:
How much is the optional standard deduction?
Answer:
OSD (300,000 x 40%) 120,000

3. T reported the following for the period:

Sales P1,000,000
 Cost of sales 300,000
Operating expenses 100,000
Required:
How much is the optional standard deduction if T is a corporation?
Answer:
OSD (1,000,000 – 300,000 = 700,000 x 40%) 280,000

4. Krell Corporation showed the following data during the taxable year:
Sales P500,000
Interest income, net of 20% final tax 24,000
Cost of sales 300,000
Salary expense 120,000
Rent expense 24,000
Advertising expense 6,000
Depreciation expense 5,000
NOLCO 50,000
Required:
How much is the amount of regular itemized deduction?
Answer:
Salary expense 120,000
Rent expense 24,000
Advertising expense 6,000
Depreciation expense 5,000
Total 155,000

5. A business reported a total net revenue of P5,000,000. The actual entertainment and
representation expenses incurred in connection with the conduct of business
amounted to P30,000.
Required:
If the business is a trading business, the deductible amount of representation and
entertainment expenses is?
Answer:
Trading – limit lower (5,000,000 x .005) 25,000