Should I Choose Itemized Deductions or OSD?

Taxumo
Taxumo
Aug 9, 2017 · 3 min read
Decisions, decisions [Image: Pixabay.com]

When you file your quarterly and annual income taxes, you’ll come upon this item: Method of Deduction.

And you’ll receive two options: Itemized Deduction and 40% Optional Standard Deduction, better known as OSD.

What do those terms mean, and which should you choose?

Itemized deduction means you’ll need to list every single business-related expense you’ve made.

This includes overhead expenses and, of course, the amount you paid to directly purchase or produce your main product.

For instance, if your business involves buying and selling baby clothes online, then under Itemized Deduction, you would have to list how much it cost you to

  • find suppliers and communicate with them (communication expenses)
  • purchase those clothes from your supplier (direct purchase expenses)
  • have them shipped to your warehouse (shipping charges)
  • find buyers (marketing expenses)
  • send items to buyers (more shipping charges)
  • and receive payment (bank charges, Paypal charges, etc.).

Now suppose you were able to sell all those clothes for P100,000 but you had to shell out P65,000 to buy and then sell and ship them, then your taxable income would only be P35,000 (P100,000 minus P55,000).

That’s good news! The smaller you can make your taxable income, the better, right?

Of course, you’ll need to prove to the Bureau of Internal Revenue (BIR) that you actually spent all that money on your business.

So you need to be meticulous in listing down all your business-related expenses. And you’ll need to keep all the official receipts and sales invoices you receive.

People like to use itemized deductions because it gives them so much control on how much taxable income they’ll end up with. If you’re an avid collector of receipts, you could end up with no taxable income at all, under the itemized deductions scheme.

Of course, the BIR is aware of this. That is why, if you are filing under itemized deductions, they are also very enthusiastic and rigorous in auditing your books of accounts.

OSD removes from taxpayers the burden of having to keep track of expenses.

“Fine,” it says. “Don’t tell me how much you spent. Just tell me how much money you’ve received, and I’ll consider 40% of it as your expenses. So you only get taxed for 60%.”

Now let’s go back to our buy-and-sell baby clothes business: If you sold all your merchandise for P100,000, then under the OSD system, your taxable income would be P60,000 (60% of P100,000).

Notice how much larger your taxable income is now, compared to the P35,000 that you ended up with under itemized deduction.

The thing with OSD is that it works okay if, say, you had really low overhead costs and a really high markup for your items.

But what if your markup is only 30%? What if, for every P100,000 you earned, you actually kept only P30,000, not P60,000?

Then, under OSD, you’d be getting taxed for income you didn’t actually get. Ouch!

What’s extremely attractive about OSD is, since you’re not able to reduce your taxes by padding your expenses, the BIR is more lenient towards OSD filers.

In fact, OSD filers hardly ever get audited.

So let’s return to the question: Should you choose Itemized Deduction or OSD?

It’s a good idea to choose Itemized Deduction if

  • Your expenses are larger than 40% of your revenue, and
  • You are able to keep meticulous records of your revenues and expenses.

It’s a good idea to choose OSD if

  • Your business is service oriented and does not involve purchasing merchandise
  • Your actual expenses are less than or equal to 40% of your revenue
  • You are unable to keep impeccable books of accounts
  • The idea of getting audited prevents you from sleeping soundly at night.

Taxumo

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Taxumo

Taxumo is a web-based tax submission platform that helps freelancers, professionals, and self-employed individuals file and pay for their taxes online.

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