How to Compute Income Tax in the Philippines

Income tax in the Philippines is a fundamental aspect of the nation’s financial system, contributing significantly to government revenue. Understanding how to compute this tax is essential for individuals and businesses operating within the country. This guide aims to clarify the income tax computation process, from identifying taxable income to applying the correct rates, helping taxpayers determine their obligations and ensure compliance.

Who is Subject to Philippine Income Tax

The tax liability of individuals and corporations in the Philippines depends largely on their residency and the source of their income. For individuals, distinct classifications determine the scope of their taxable income. Resident citizens, for instance, are subject to Philippine income tax on all income derived from both within and outside the Philippines, meaning their worldwide income is considered.

Non-resident citizens and aliens, whether resident or not, are taxed solely on income sourced from within the Philippines. A non-resident alien engaged in trade or business in the Philippines is generally taxed like a citizen or resident alien, but only on their Philippine-sourced income. Conversely, a non-resident alien not engaged in trade or business is subject to a flat 25% tax on their gross income from Philippine sources.

For corporate entities, rules vary based on their establishment and operational presence. Domestic corporations, formed under Philippine laws, are taxed on their worldwide income, similar to resident citizens. Resident foreign corporations, though organized under foreign laws, are engaged in trade or business within the Philippines and are taxed only on income derived from Philippine sources. Non-resident foreign corporations are subject to a 25% income tax on their gross income received from all sources within the Philippines.

Determining Gross Taxable Income

Identifying all sources of gross taxable income is the foundational step in computing income tax in the Philippines. This encompasses various forms of earnings, each with specific considerations for tax purposes. Compensation income includes salaries, wages, emoluments, and other benefits received by an employee, such as bonuses. Mandatory contributions to government-mandated benefits like SSS, PhilHealth, and Pag-IBIG are generally excluded from taxable compensation.

Income derived from business or the practice of a profession represents another significant category. This includes gross sales or receipts from a trade, business, or profession, as well as income from other non-operating sources. For self-employed individuals and professionals, this income is subject to the graduated income tax rates. However, those with gross sales or receipts and other non-operating income not exceeding the value-added tax (VAT) threshold, currently PHP 3 million, have the option to be taxed at an 8% flat rate on their gross sales or receipts in excess of PHP 250,000, in lieu of the graduated rates and percentage tax.

Passive income, generally earned without active participation from the taxpayer, is also subject to income tax, often at final withholding tax rates. This category includes interest income from bank deposits, royalties, and dividends. For example, dividends distributed by a resident company to individual citizens and resident aliens are subject to a 10% final withholding tax. Interest income from bank deposits is taxed at a final rate of 20%.

Capital gains, which are profits from the sale of capital assets, constitute another taxable income source. Gains from the sale of shares in domestic corporations not traded on a stock exchange are subject to a 15% capital gains tax on the net capital gain. For the sale of real property classified as a capital asset, a 6% final withholding tax is imposed on the gross selling price or the current fair market value, whichever is higher. Accurately identifying all these income streams is crucial for a complete tax computation.

Allowable Deductions and Exemptions

After determining gross taxable income, the next step involves applying allowable deductions and exemptions to arrive at net taxable income. The Tax Reform for Acceleration and Inclusion (TRAIN) Law (Republic Act No. 10963) reformed the individual income tax structure, repealing the previous system of personal and additional exemptions.

The TRAIN Law introduced a higher zero-tax bracket, making the first PHP 250,000 of annual taxable income tax-exempt for all individual taxpayers. For compensation earners, non-taxable deductions include mandatory contributions to social security, health insurance, and provident funds (SSS, PhilHealth, Pag-IBIG). The 13th-month pay and other bonuses are also exempt up to PHP 90,000.

For individuals earning income from business or a profession, deductions can be more varied. They can choose between itemized deductions or the Optional Standard Deduction (OSD). Itemized deductions allow taxpayers to subtract ordinary and necessary expenses directly incurred in their trade, business, or profession, which must be substantiated.

Alternatively, the OSD allows a deduction of 40% of their gross sales or gross receipts, without the need to substantiate individual expenses. This option simplifies record-keeping for many small businesses and professionals. Once a deduction method is chosen for a taxable year, it is irrevocable for that year.

Applying Income Tax Rates

Once net taxable income is determined, the appropriate income tax rates are applied to calculate the tentative tax due. For individuals, the Philippines employs a progressive graduated income tax rate system. This means that different portions of income are taxed at increasing rates, with higher income levels subject to higher tax percentages. As of January 1, 2023, rates start at 0% for income up to PHP 250,000.

Beyond this tax-exempt threshold, rates progress from 15% for income exceeding PHP 250,000 up to PHP 400,000, to a maximum of 35% for income above PHP 8,000,000. For example, if an individual’s net taxable income is PHP 300,000, the first PHP 250,000 is tax-exempt, and the remaining PHP 50,000 is taxed at 15%. This structure ensures that individuals with higher incomes contribute proportionally more to the tax base.

Self-employed individuals and professionals can opt for an 8% flat tax on their gross sales/receipts in excess of PHP 250,000 if their gross income does not exceed PHP 3 million. If their income exceeds this threshold, they must use the graduated income tax rates.

For corporations, the standard corporate income tax (CIT) rate is 25% of net taxable income. A preferential rate of 20% applies to domestic micro, small, and medium-sized companies meeting specific criteria: taxable income up to PHP 5 million and total assets not exceeding PHP 100 million (excluding land). Domestic and resident foreign corporations are also subject to a Minimum Corporate Income Tax (MCIT) of 2% of their gross income, applied from the beginning of the fourth taxable year of business operations. Corporations must pay either the regular CIT or the MCIT, whichever is higher.

Calculating Final Tax Due

The final step in income tax computation consolidates all preceding calculations to arrive at the actual tax payable or refundable. After calculating the tentative income tax due, any creditable withholding taxes (CWT) are subtracted.

Withholding tax is an amount deducted by the payor of income and remitted to the Bureau of Internal Revenue (BIR) on behalf of the payee. This includes expanded withholding tax (EWT) on income payments such as professional fees, rental payments, and payments to contractors. The withheld amount acts as a prepayment of the income tax liability and is credited against the payee’s total tax due at the end of the taxable year.

For compensation earners, their employers are responsible for withholding taxes from their salaries and remitting these amounts to the BIR. If the total amount withheld by the employer exceeds the computed final tax due, the employee may be entitled to a tax refund. Conversely, if the withheld amount is less than the final tax due, the employee must pay the remaining balance.

The final tax due is calculated as: Gross Taxable Income minus Allowable Deductions and Exemptions equals Net Taxable Income. Then, Net Taxable Income multiplied by the Applicable Tax Rate yields the Tentative Income Tax Due. Finally, the Tentative Income Tax Due less any Creditable Withholding Taxes results in the Final Tax Payable or Refundable. This systematic approach ensures that all income and pre-payments are accounted for in determining the ultimate tax obligation.