Which should I choose: itemized deduction or optional standard deduction?

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When filing your first quarterly ITR, you have to choose between itemized deduction and optional standard deduction (OSD) if you’ll avail of the graduated tax rates.

It’s an important decision to make, as your choice takes effect the entire year, and you can’t change it until the start of the next tax year.

To help you decide, here are the pros and cons of each deduction method:

 

Option 1: Itemized deduction.

Advantages.

  • It can result in higher deductions (as long as you have supporting documents) than what you can claim with the OSD method, especially if you have large business expenses.
  • You have control over your taxable income. The more receipts, invoices, bills, and other supporting documents you can collect, the better chances you have at lowering your income tax.
  • Under itemized deduction, you won’t be required to pay income tax if you incur losses during the taxable year.

 

Disadvantages.

  • You have to list down your every business expense and keep the corresponding receipt (up to 10 years) or proof of the deductible expense. This, in itself, is a tedious task that requires a lot of time and patience.
  • You should be very meticulous and careful in auditing your records to avoid errors in your tax computation.
  • If you don’t want to handle the tracking and itemizing of your business expenses, you can hire an accountant. You’re required to get a certified public accountant (CPA) to audit and manage your books of accounts if your gross annual sales or receipts exceed Php 3 million. Either way, it can cost you money.

 

Option 2: Optional standard deduction (OSD).

Advantages.

  • Because the deduction is fixed at 40% of gross sales or receipts, the OSD is easier to compute than the itemized deduction.
  • The tax due is more predictable because the taxable income is automatically 60% of your gross sales/receipts.
    It doesn’t require listing, tracking, and computing your expenses (However, keeping records of business expenses is still required).
  • No need to submit the BIR Form 1701 AIF (Account Information Form) or Financial Statements.
  • You’re not required to hire a CPA.
  • The BIR hardly audits the expenses of OSD filers.

 

Disadvantages.

  • If your business expenses exceed your income, filing under OSD will result in higher tax due than an itemized deduction.
  • You may lose more money because 60% of your gross sales or receipts are automatically taxed, whether or not you made a profit for the year.
  • You’re still required to pay income tax even if you incur losses during the taxable year.

 

Itemized deduction vs. OSD: Which is the better method for you?

Filing income tax under itemized deduction is a good idea if you can keep records of all your business expenses, and your expenses are higher than 40% of your gross receipts or sales.

If you’re a non-resident foreigner earning income from a business in the Philippines, you can use only the itemized deduction.

On the other hand, choose the optional standard deduction method under any of these circumstances:

  • You incur low business expenses, ideally less than 40% of your gross sales or receipts.
  • You hate the idea of getting audited, and you prefer a simpler and more straightforward way to compute your income tax.
  • You’re not confident about keeping accurate books of accounts.
  • You’re a freelancer without regular business expenses.

Go back to the main article: How to Compute Your Income Tax Using the New BIR Tax Rate Table