Chapter 7

1. Scope of the regular income tax, especially on passive income and capital gains.
a. Regular income tax covers all taxable income earned by individuals and corporations,
such as compensation, business income, professional income, passive income, and
certain capital gains. Passive income—like interest, royalties, and cash dividends—is
generally subject to final taxes, meaning they are taxed separately at special rates.
Capital gains from the sale of certain assets, like domestic shares not traded on the stock
exchange or real property classified as capital assets, are also covered but taxed under
special capital gains tax rules. In short, regular income tax covers active income, while
passive income and capital gains are taxed under their own specific provisions.
2. Characteristics of the regular income tax.
a. Regular income tax is imposed on a taxpayer’s taxable income, which is gross income
minus allowable deductions. It is computed on a progressive rate for individuals, meaning
higher income is taxed at higher percentages, while corporations pay at flat rates. It
applies to income earned from work, business, or profession and must be reported
annually. The tax focuses on actual profit or gain, unlike final or capital gains taxes which
are imposed separately and no longer included in the annual return.
3. Allowable deductions from personal exemptions.
a. Allowable deductions are expenses that taxpayers may subtract from their gross income
to reduce taxable income when those expenses are necessary and ordinary for business
or professional activities. Personal exemptions, on the other hand, are amounts
previously allowed to individuals to account for basic personal living expenses—but
under TRAIN Law, personal exemptions have been removed for individuals. Today, only
allowable deductions are used to reduce taxable income, while personal exemptions no
longer apply.
4. Demonstrate the computation of the gross income from employment and the gross income from
business or exercise of profession.
a. Gross income from employment includes all forms of compensation: salaries, wages,
bonuses, allowances, taxable benefits, and any income you receive because of your job.
Meanwhile, gross income from business or profession includes total sales or receipts
before deducting any expenses. This means that for a business or professional practice,
gross income is the total amount earned from customers or clients before considering the
cost of operations.
5. How is income from sales of goods determined?
a. Income from the sale of goods is determined by computing the sales revenue and then
subtracting the cost of the goods sold. To find cost of goods sold, you consider the
beginning inventory, add purchases or production costs, and subtract the ending
 inventory. Whatever is left is the cost attributed to the goods that were actually sold,
letting you determine the gross profit.
6. What are included in cost of services?
a. Cost of services includes all amounts spent directly to perform or deliver a service. This
includes salaries of employees providing the service, service-related materials, supplies,
utilities used for service delivery, and other direct operating expenses. These costs
represent what it takes to actually perform the service for clients or customers.
7. What composes the compensation income of a rank-and-file employee and a managerial
employee?
a. Both rank-and-file and managerial employees have compensation income consisting of
salaries, wages, allowances, bonuses, and non-exempt benefits. The main difference is
that managerial employees often receive more complex compensation packages—such
as representation allowances or higher bonuses—but for tax purposes, their
compensation items are treated the same. Compensation income includes everything
earned due to employer-employee relationships.
8. How does the tax presentation of the composition of gross income in the tax return differ between
individuals and corporate taxpayers?
a. Individuals report several classifications of income separately, such as compensation
income, business or professional income, passive income, and capital gains—each with
its own tax treatment. Corporations, however, present gross income mainly as gross
sales or gross receipts minus cost of goods or services, because corporations do not
have compensation income. Corporations also apply a flat tax rate instead of progressive
brackets, making their tax return structure more unified.
9. Distinguish revenue income and income from operations, from non-operating income.
a. Revenue income or operating income refers to earnings that come from the main
business activities, such as sales of goods or service fees. Non-operating income,
meanwhile, comes from activities not related to the main business—such as interest
income, rental income, or gains from selling investments. Operating income shows what
the business earns from its core purpose, while non-operating income reflects side or
incidental earnings.
10. Discuss how the taxable income of the following is determined: Corporate taxpayer, purely
compensation earner, business/professional income earner, mixed-income earner.
a. A corporate taxpayer determines taxable income by taking gross income from sales or
services and subtracting allowable deductions or optional standard deductions to arrive at
net taxable income, which is then taxed at the corporate rate. A purely compensation
earner determines taxable income simply by taking total compensation income and
applying withholding tax rules; there are no deductions allowed other than non-taxable
 benefits. A business or professional income earner computes taxable income by taking
gross sales or receipts, subtracting cost of goods or services, and then subtracting
allowable deductions. A mixed-income earner combines compensation income taxed
under the withholding system and business or professional income taxed under regular
income tax, placing them together in the annual return.
11. Discuss the treatment of net loss from business or exercise of profession.
a. A net loss from business or profession may generally be carried over as part of the Net
Operating Loss Carry Over (NOLCO), allowing it to be deducted from taxable income in
the next three years, provided no ownership change rules are violated. This rule helps
businesses recover from loss years by reducing taxable income in future profitable years.
Individuals earning purely compensation income cannot use NOLCO—it applies only to
business or professional operations.
12. What are taxable income and receipts from non-operating income
a. Non-operating income includes earnings not related to the core business, such as
interest, dividends, rental income, or gains from selling assets. These amounts are still
taxable unless specifically exempt. Although they do not come from the primary business
activity, they must be included in the taxpayer’s computation of total taxable income for
the year.
13. Discuss the treatment of net loss from business or exercise of profession.
a. A net loss from business or the practice of a profession may be carried forward and used
as a deduction in future years under the Net Operating Loss Carry-Over (NOLCO) rule.
This allows the taxpayer to subtract the loss from their taxable income for the next three
consecutive taxable years, helping reduce tax when the business becomes profitable
again. However, the loss can only be used if there is no substantial change in
ownership and if the loss came from operations (not from activities outside business).
Individuals who only earn compensation income cannot use NOLCO—only business
owners and professionals are allowed.
14. What are the deadlines of the quarterly/regular income tax for individuals and corporations?
a. For individual taxpayers earning business or professional income, the quarterly income
tax returns must be filed every April 15, August 15, and November 15, while the annual
income tax return is due every April 15 of the following year. For corporations,
quarterly returns must be filed within 60 days after the end of each quarter, and their
annual return is due on the 15th day of the fourth month after the end of their fiscal
year. Corporations may follow either a calendar year or a fiscal year, while individuals
always follow the calendar year.