Q: It’s tax season once again and my accountant has been asking me for information on how much income I earned last year as part of their preparation for my annual income tax return this April. Are all earnings subject to income tax? Please advise. – Jen Rodriguez, by email
There is a saying that in life, there are only two things that are certain – death and taxes. When you earn income, you will certainly be liable to taxes in one way or another.
While it is true that all income is subject to taxes, not all income that you earn is subject to your annual income tax returns. There are several types of income that are not subject to income tax because you may have paid your taxes on it already.
You may not be aware of it because the taxes have already been deducted from your income before you have received it. The tax that you have paid is what the Bureau of Internal Revenue (BIR) call as Final Withholding Tax.
All transactions that are subject to Final Withholding Tax shall not be included in the annual taxable income for assessment anymore. Such transactions are enumerated by the Tax Code of the Philippines, but for those that affect your personal finance, here are the five most common investment gains that are not subject to income tax:
1. Interest income
When you put your money in the bank, the interest that you earn is subject to a 20-percent final tax. Normally, you would not notice this because when you receive your interest, the tax is already deducted before the amount is credited to your account.
Your borrower, which in this case happens to be your bank, is mandated by law to act as your withholding agent, whose function is to remit your taxes to the government on your behalf.
Because of this, you don’t have to do anything as the taxes deducted shall be considered as your final payment on the interest income earned.
Interest rates can range from as low as regular savings account rate to as high as those earned from investing in fixed income securities such as bonds. When you invest in bonds that pay six percent per year, you can assume that the net interest you will earn will only be 4.8 percent because of the 20-percent final tax.
2. Dividend income
When you invest in stocks, there are some stocks that pay dividends once or twice a year. The dividend income that you receive from your investment shall be subject to final tax of 10 percent.
Similar to interest income, your dividend income will be deducted by 10 percent final tax before it is credited to your account with your broker. If you are investing in preferred shares where the dividend rate is around six percent per year, you can assume that your annual income will net only about 5.4 percent because of the taxes.
3. Gains from sale of stocks
If you keep a portfolio of stocks as your investment and trade regularly in the stock market, the gains that you make are not subject to income tax because you have already paid 0.5 percent capital gains tax on it.
Every time you sell your stocks in the market, whether you made money or not, you are automatically charged capital gains tax, which serves as your final tax.
If you sell a stock of a private company, meaning the shares are not listed in the stock market, there is capital gains tax of five percent for gains not exceeding Php100,000. More than that, the capital gains tax shall be 10 percent.
Again, once these taxes have been paid and ownership of shares have been transferred, the gains from the sale of the shares shall not be included in the annual income tax returns.
4. Gains from sale of real estate
Unless you have a full-time real estate business where you buy and sell regularly, the gains you make by selling your condo or townhouse shall not be subject to income tax. When you sell, your transaction shall be charged with a six-percent capital gains tax. Similar to the sale of listed stocks, you shall pay capital gains tax regardless of whether you made money or not.
When you invest in real estate, make sure that you are doing this as a long-term investment. If you are planning to buy several condo units with the intention of selling it immediately within the year or so, your transaction may not qualify for final tax, as the properties you invested may be considered ordinary assets, which are subject to regular income tax, rather than capital assets.
5. Gains from sales of mutual fund shares
Perhaps investing in mutual funds offers the best tax incentive of all. There is no capital gains tax on redemption of mutual fund shares. When you invest in mutual funds, you deposit your money into the mutual fund company, which pools your money with other investors and invest in various securities such as bonds and stocks.
When the market value of the investment holdings of the mutual fund appreciates, its net asset value per share will also increase. This is where you will make money from mutual fund investing. Unlike in the stock market, you can only sell your mutual fund shares back to the company and not to other investors. The gains you make by selling your mutual funds share shall be free of any capital gains tax.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice email@example.com or follow him on Twitter @henryong888