For freelancers, professionals or entrepreneurs (either a single person proprietorship or entity – partnership, corporation) that get to file their own taxes, you can use business expenses to lower your net income, hence, your income tax as well. These are called deductions. The Tax Deduction Scheme is based on the sales and expenses you expect to happen in the year. The deadline for choosing this is April of each year (quarterly filing).
Here’s a brief overview on how you can save with the Tax Deduction Scheme:
100% Declared (Gross) Income – XX% taxable
100% Gross Income – Deductions = Net Income (lower than gross income)
Net income – XX% taxable = Lower Tax
Tax Deduction Scheme
Types of Tax Deduction Schemes
There are two types of tax deduction schemes: itemized and optional.
Take note that whatever type of deduction scheme you choose in the first quarter of the year (April of each year) is the one applied throughout the year.
Choose wisely. Here is an overview on each type to help you decide what works best for your anticipated business expenses:
Optional Standard Deduction (OSD)
In this deduction scheme, 40% of your gross income is automatically declared as business or operation expenses. This means that 60% of your gross income would be considered as your net income and be taxable.
This is a fixed deduction scheme, regardless of your income OR monthly operating expenses. This is an advantage for businesses that have fairly low operating expenses (no office rental for example) and is easy as there is no audit of expenses needed.
In this deduction scheme, a business declares all valid expenses (subject to rules and limitations). This is an advantage for businesses that have big operating expenses (office rent, marketing materials, travel costs, equipment) as deductions can exceed 40% and it will result in lower taxes.
However, this deduction scheme calls for a thorough auditing of expenses and the need to be organized with itemized expenses. Expenses must be supported by receipts, records or other pertinent papers and are valid if these are made during the taxable year. Businesses with no receipts (fare expenses like commuting via jeepneys, MRT/LRT, etc) are not counted.
What Qualifies Under Operating Expenses?
These are examples of operating expenses. This can help you estimate your monthly operating expenses and gauge what type of deduction scheme will be better for your business.
• Rent and utilities (office rent/co-working space rent, internet, phone, electricity, website hosting fees)
• Transportation expenses (car payments, gas, taxi, train)
• Furniture and equipment (laptop, printer, camera, scanner, projector)
• Materials (printer ink, paper, office supplies)
• Outside hired (outsourced) services (accountant, bookkeeper, web designer)
• Entertainment & Recreation (client meetings, meals, client gifts)
• Training/Education expenses (conferences, museums, books, seminar, travel, workshops)
• Marketing expenses (business cards, website, portfolio)
• Cost of Service (expenses directly related to your creative output) – labor and supplies