To tax or not to tax compensation?

On May 1, 1903, the first Labor Day was celebrated in the Philippines. Thousands of workers marched from the streets of Tondo, Manila to Malacañang Palace to voice their demands for better working conditions and fair treatment from the then American-ruled administration. Fast forward one hundred and twenty years later, we are still commemorating the contributions of our labor force, which has helped build and develop the nation after years of immeasurable hard work and perseverance.

Perhaps, one of the most recurring issues raised every Labor Day is the demand for higher wages. Related to this, from the point of view of taxpayers, the amount of take-home pay received by employees, after deducting the withholding tax on their compensation, is vital to each individual employee-taxpayer.

Thus, having an understanding of the rules and regulations surrounding what constitutes taxable and non-taxable income is crucial for employees and employers alike, to avoid disputes in determining how much tax should be deducted from taxpayers’ hard-earned money.

To arrive at taxable compensation, non-taxable income is deducted from gross compensation. All forms of compensation are generally included as part of the taxable income unless they are specifically allowed by tax rules to be treated as non-taxable income.

Below are some of the more common compensation items or employee benefits and their related tax treatments.

Fixed or variable allowances are generally considered taxable compensation.  However, there are types of allowances included in the list of de minimis benefits under Revenue Regulations (RR) No. 5-2011, as updated by the Tax Reform for Acceleration and Inclusion (TRAIN) Law, which are not taxable. These non-taxable allowances consist of the following:

a. P250 monthly medical allowance to dependents of employees;

b. P2,000 monthly rice allowance;

c. P300 monthly laundry allowance;

d. P6,000 annual uniform and clothing allowance; and

e. Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of the basic minimum wage.

With regard to the above daily meal allowance, the Bureau of Internal Revenue (BIR) clarified through BIR Ruling No. 544-12 that daily meal allowance not given on occasion of overtime work cannot be classified as a de minimis benefit. Hence, daily meal allowances provided to employees will be considered taxable, unless specifically intended for overtime work.

Any other allowances not included in the list of de minimis benefits, such as communication allowance, travel allowance, fuel allowance, and housing allowance, will be generally included as part of taxable compensation of employees. Note, however, that when the allowances are provided for expenses incurred or expected to be incurred by an employee in the performance of his duties and are necessary in pursuit of the trade or business of the employer, these are not considered compensation subject to withholding tax, as long as the allowance is subject to accounting or liquidation by the employee in accordance with the substantiation requirements of Section 34 of the Tax Code, as amended.

Included in the list of de minimis benefits prescribed by the BIR is actual medical assistance not exceeding P10,000 per year. Hence, any medical assistance provided within the prescribed threshold can be considered non-taxable income.

Pursuant to BIR Ruling No. 019-02, the medical assistance provided to employees must be for their own medical expenses. Further, the medical assistance must be fully substantiated with actual official receipts.

RR No. 5-2011 cited examples of medical assistance such as expenses for “medical and healthcare needs,” annual executive check-up, maternity assistance, and routine consultations.

For private employees, unused vacation leave credits not exceeding 10 days converted to cash are considered non-taxable de minimis benefits during the year. Meanwhile, for government officials and employees, the monetized value of both vacation and sick leave is considered a de minimis benefit.

Hence, without specific BIR issuances/tax exemption rules, conversion to cash of other leave benefits, such as birthday leave, bereavement leave, and emergency leave, will unfortunately be considered taxable income.

The mandatory 13th month pay and other additional benefits granted by employers, such as 14th month pay, performance bonus, health bonus, perfect attendance bonus, and all other types of bonus, may be considered non-taxable compensation but only up to P90,000. Any amount in excess of the P90,000 ceiling may not be allowed as deductions against gross income and forms part of the taxable income of employees.

“Other benefits” considered in computing for the amount subject to the P90,000 threshold include fringe benefits provided to rank-and-file employees, benefits in excess of the de minimis thresholds, loyalty awards, and gifts given in cash or in kind. Hence, these benefits are generally considered taxable, unless the aggregate amount of 13th month pay and other benefits of the employee does not exceed the P90,000 ceiling.

Discussed above are just some of the usual benefits received by employees as hard-earned fruits of their labor. Such fruits of labor should be carefully evaluated on whether they should be taxed or not, as tax treatments certainly have an impact on the take-home pay of employees.

And as another Labor Day comes to a close, we are reminded of how vital the role of our labor force is in the development of our economy. They should be treated fairly and their compensation should be taxed or not taxed accordingly.

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.


Patrick Manuel R. Olarte is a senior in charge from the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.