SOUTH EAST ASIAN INSTITUTE OF TECHNOLOGY, INC.

Accounting Information System Department

National Highway, Crossing Rubber, Tupi, South Cotabato

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LEARNING MODULE FOR

BT 211
TAXATION (INCOME TAXATION)

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WEEK 5

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 WEEK 5
CO-OWNERSHIP, ESTATES AND TRUSTS

Objectives:

After studying this chapter, the students should be able to:

1. Define “co-ownership.”
2. Distinguish “income of estates” from “income of trusts”;
3. Define “withholding tax”;
4. Discuss the rules of determining the taxable income of irrevocable trust from
revocable trusts;
5. Enumerate the persons required to deduct and withhold creditable withholding taxes
on income payments;
6. Identify the two classification of withholding tax at source.

Co-ownership
There is co-ownership when two or more heirs or beneficiaries inherit an undivided
property from a decedent, or when a donor makes a gift of an undivided property in favor
of two or more donees. Inheritance is subject to ‘’Estate Tax” while Donatioin is subject
to ‘’Donor’s tax’’. Both taxes are not income tax but classified as ‘’Transfer Taxes”.

When inherited property remained undivided for more than ten (10) years and no attempt
was ever made to divide the same among the co-heirs, nor was the property under
administration proceedings nor held in trust, the property should be considered as owned
by an unregistered partnership, consequently, taxable as corporation.

ESTATES
The estate is composed of all properties, rights that have including those properties,
earnings or obligations that have accrued thereto since the opening of the succession. The
estate is to be transferred from the decedent to his successors.

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During the period when the title to the properties is not yet finally transferred to the
successors, there may be earnings generated from the estate. These earnings are subject
to income tax.

Illustration

X died, leaving behind P500,000 investment in securities to his wife and son. In his last will
and testament, the investment is to be held in trust for the wife and son.

The annual income of the trust is assigned to the wife as beneficiary during her lifetime and
the trust will be terminated upon her death and the son, as beneficiary, will receive the
investment in securities.

If the expected annual income from the investment is P60,000, the P500,000 is subject to
transfer tax (estate tax) while the P60,000 income (if realized) is subject to income tax.

TAXABLE INCOME AND TAX RATES

For taxation purposes, the taxable income of the estate/ trust shall be determined in the
same manner and basis as in the case of individual taxpayers. The items composing the
taxable income and tax of the income from estates / trusts are as follows:

1. Gross Income

The items of gross income of estates/ trusts are the same items as the items of gross
income of individual taxpayers.

2. Deduction

Deductions from the gross income of estates/trusts are the same as the items of deduction
allowed to individual taxpayer.

3. Special Deduction

In addition to the allowable deductions under Section 34 of the Tax Code, estates are also
allowed to deduct the amount of income of the estates during the taxable year that is paid
or credited to the legatee, heir or beneficiary, subject to a creditable withholding tax of
fifteen percent (15%).

However, the amount so allowed as a deduction shall be a part of the taxable income of
the legatee, heir or beneficiary. Any portion of the gross estate paid to the heir is not
deductible from the gross income of the estates.

In case of a trust administered in a foreign country, this deduction shall not be allowed.
Provided, that the amount of any income included in the return of said trust shall not be
included in computing the income of the beneficiaries.

5. Taxable Income

The taxable income of estates / trusts shall be computed in the same manner and on the

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same basis as in the case of individual taxpayer.

6.Tax Rate

The tax rate applicable is the tax rate prescribed for individual taxpayers (see table below
for rates).

Source: rappler.com

Illustration

On November 1, 2018, Juan de la Cruz died leaving various property worth ₱30,000,000.
The properties are income producing properties deriving rental income. The net income
from rentals for 2019 amounted to ₱2,500,000. A “last will and testament” was executed by
the decedent prior to his death assigning Atty. Gerardo Javier as the executor. In 2019,
while under administration, the estate earned ₱4,750,000 (net of 5% creditable withholding
tax on rent, amounting to ₱250,000) and incurred operating expenses of ₱2,000,000.

Question 1: How much is the taxable income of the Estate of Juan de la Cruz in 2018?

Question 2: How much is income tax payable of the Estate of Juan de la Cruz in 2019?

Another Illustration

Assume that the same facts are given as the previous example, and that the following
additional facts are considered:

During 2020, Pedro de la Cruz, one of the lawful heirs, received ₱200,000 from the income
of the estate. Pedro’s other income and expenses were as follows:

Compensation income ₱800,000

Business income 1,500,000
Business expenses 600,000

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Question 1: Assume that the estate is still under administration, how much is the taxable
income of the estate in 2020?

Answer: ₱2,800,000

Solution:

Gross rental income (4.75M + 250K) ₱5,000,000

Allowable business expenses (2,000,000)
Distribution of income to Pedro (heir) (200,000)
Taxable income ₱2,800,000

Question 2: How much is the taxable income of Pedro?

Answer: ₱1,900,000

Solution:

Compensation income ₱ 800,000

Business income 1,500,000
Business expenses (600,000)
Amount received from income of the estate (from above) 200,000
Taxable income ₱1,900,000

TRUSTS

A trust is an obligation imposed or a right to administer over a property given to a person

for the benefit of another.

This is a legal institution used to administer funds in behalf of individuals or organizations.

Trust device is used frequently to transfer property from one generation to another.

Illustration

Suppose J wants his wife to have the income from his estate as long as she lives. J may
place his property in a trust, the income of which would go to his wife for life; the trust would
be dissolved upon her death and the property distributed to the children. The trust is to be
administered by Attorney Nilo, a trustee.

Under this arrangement, the trustee is required by law to manage the trust strictly in
accordance with the terms of the trust instrument.

When a trust is created, a new entity comes into being for which returns must be filed and
taxes be paid.

Income accumulated in trust and/or to be distributed to beneficiary is subject to income tax.

A trust created by a written instrument other than a will is known as a trust inter-vivos, if
created by will, it is known as a testamentary trust.

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INCOME DERIVED FROM TRUSTS

Tax imposed upon individual taxpayers shall apply to the income of any property held in
trust, including:

1. Income accumulated in trust for the benefit of unborn or unascertained person(s)

with contingent interests, and income accumulated or held for future distribution
under the terms of the will or trust;
2. Income that is to be distributed currently by the fiduciary to the beneficiaries, and
income collected by a guardian of an infant that is to be held or distributed as the
court may direct;
3. Income that, in the discretion of the fiduciary, may be distributed to the beneficiaries
or accumulated.

The trust, or the beneficiaries or the grantor may pay the tax on income derived from trusts.

COMPUTATION OF TRUST’S INCOME TAX

The computation of the net taxable income of trust shall be in the same manner as that of
the net taxable income of an estate. The net taxable income shall be taxed by using the
graduated tabular (normal) tax for an individual taxpayer based on Sec. 24A of the Tax
Code.

Illustration – One Trust

Mr. Sy Gurado created a Trust assigning Atty. Ver Dugo as trustee. In 2020, the trust’s
income, expenses and income distribution are as follows:

Rental income P480,000

Related allowable expenses 40,000
Income distributed to Miss Fanie Durado, the beneficiary 160,000

The related income tax is computed as follows:

Gross income P480,000

Less: Related expenses P40,000
Amount distributed to beneficiary 160,000 200,000
Net income P280,000

Income tax on P250,000 P --0--

Excess (P30,000 x 20%) 6,000
Total income tax due P 6,000

*The P160,000 distributed income must be included in the taxable income of the recipient.

TWO OR MORE TRUSTS

In the case of two or more trusts created by the same person for the same beneficiary, the
taxable income of all trusts shall be consolidated and the tax shall be computed based on
the consolidated income.

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The proportionate amount of the tax computed based on the consolidated income shall be
assessed and collected from each trustee. The said amount of tax should be proportionate
to the taxable income of the trust administered by the trustee to the consolidated income
of the several trusts.

Illustration

Mr. Mar Don created two irrevocable trusts: a trust (Trust A) on his property located in
Baguio for his only son, assigning Atty. Pis as trustee, and another trust (Trust B) on his
property located in La Union, also for his son, but this time naming Atty. Lasap as the trustee.

For year 2020, the two trustees reported the following income and expenses:

Gross Distribution to Quarterly

Income Expenses Beneficiary Tax Paid
Trust A P140,000 P30,000 P10,000 P1,000
Trust B 260,000 60,000 30,000 2,000
Total P400,000 P90,000 P40,000 P3,000

To compute for income tax still due of the two trusts would be

Trusts A Trusts B Total

Taxable income before exemption P100,000 P170,000 P270,000
Consolidated taxable income P270,000

Income tax due P 4,000

Allocation of P4,000:
Trust A (P4,000 x 10 / 27) P1,481
Trust B (P4,000 x 17 / 27) P2,519 P4,000
Less: Income taxes already paid 1,000 2,000 3,000
Income tax still due P 481 P 519 P1,000

NOTE: The fraction of allocation is based on the taxable income before absolute exemption.

REVOCABLE TRUSTS

Generally, revocable trusts, exist when the trustor (grantor) reserves the power to change
at any time any part of the terms of the trust.

For tax purposes, the rule is that the grantor is liable for the income of a revocable trust.

Illustration

Mrs. Caduda Duda created a trust naming his eldest son as revocable beneficiary who will
receive the income of the trust. If the eldest son could not abide with the rules provided in
the trust instrument, Mrs. Duda could change outrightly the terms of the trust. For the year,
the trust earned a total income of P200,000. How much would be the taxable income of the
trust?

There is no taxable income of the trust because it is a revocable trust. The income should
be reported as taxable income of the grantor, Mrs. Caduda Duda.

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WITHHOLDING TAXES
Withholding of taxes is a systematic way of collecting taxes at source, an indispensable
method of collecting taxes to ensure adequate revenue for the government.

The withholding tax agent who is usually an employer or a person from whom the income
is derived does this process through withholding the appropriate amount of taxes from
taxpayers. It is designed to ensure the collection at source of income taxes.

If withholding tax is not withheld from income payments, there will be a disallowance of
deductible business expenses claimed by the withholding agent in his income tax return or
a penalty imposed on the withholding tax agent for failure to withhold the tax.

WITHHOLDING TAX AT SOURCE

A taxation at source is that part of tax system which collects through withholding agents
(payor) or employers the appropriate income taxes due as they are earned before earnings
are paid to the payees or employees.

The primary objective of the System is to ensure accurate payment of taxes and to be able
to use taxes collected at any earlier time to finance the operations and projects of the
government.

CLASSIFICATION OF WITHHOLDING TAX AT SOURCE

Withholding tax may be classified into two major categories:

1) Final Withholding Tax;

2) Creditable Withholding Tax.

FINAL WITHHOLDING TAX

Under the final withholding tax system, the amount of income tax withheld by the
withholding agent is constituted as a full and final payment of the income tax due from the
payee on the said income.

The liability for the payment of the tax rests primarily on the Payor as a withholding agent.
Thus, in case of failure to withhold or in case of under withholding, the deficiency tax shall
be collected from the payor/withholding agent.

The payee is not required to file an income tax return for the particular income, the final tax
on which has been withheld.

The finality of the withholding tax is limited only to the payee or the recipient's income tax
liability on the particular income. It does not extend to the payee's other tax liability on said
income, such as when the said income is further subject to a percentage tax.

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 To know more about Withholding Taxes, the BIR has an overview of the
Withholding Tax System on their website:
https://www.bir.gov.ph/index.php/tax-information/withholding-tax.html

CREDITABLE WITHHOLDING TAX

Under the creditable withholding tax system, taxes withheld on certain payments are
intended to equal or at least approximate the tax due of the payee on said income. The
income recipient is still required to file his income tax return as prescribed in the Section
51, of the NIRC, either to report the income and/or pay the difference between the tax
withheld and the tax due on the income.

A tax withheld on income payments covering the expanded withholding tax from
compensation income is creditable in nature.

Illustration

Let us assume that Mr. Danilo Principe, single, earned P40,000 salary per month in 2019.
His employer deducted withholding tax for the year amounting to P37,500 which has been
remitted to the BIR. Is Mr. Principe required to file income tax return on or before April 15,
2020? Will he still pay additional income tax?

Mr. Danilo Principe is still required to file his income tax return as prescribed in the Section
51 of the NIRC. His income tax will still be computed and he shall pay any difference of the
computed amount and the income tax withheld by his employer.

*Mr. Principe's income tax still due and payable would be:

*If the employer of Mr. Principe withheld a tax of P51,000, the latter would be entitled for a
tax refund of P1,000, computed as follows:

If employer of Mr. Principe did not withhold a tax, the former is required by the law to pay
the same to the BIR.

WITHHOLDING TAX ON COMPENSATION INCOME

As a general rule, all salaries earned by persons as government or non-government

employees are subject to withholding tax, except the following items:

1. Commissions paid by an insurance agent to his sub-agents.

2. Compensation for services by a citizen or resident of the Philippines for a foreign
government or an international organization.
3. Remuneration for casual labor not in the course of employer’s trade or business.
4. Remuneration for private service performed by maids, cooks, gardeners, family
drivers and the like.

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 5. Remuneration paid to agricultural labor and paid entirely in products of the farm.

LIABILITY FOR TAX

Section 2.80 of the Revenue Regulations No. 10-2008 provides the following persons liable
for the payment of withholding tax on compensation income:

1. Employer

a) ln general, the employer shall be responsible for the withholding and remittance of
the correct amount of tax required by deducting and withholding from the
compensation income of his employees. If the employer fails to withhold and remit
the correct amount of tax such tax shall be collected from the employer together
with the penalties and additions to the tax otherwise applicable.
b) b. The employer who is required to collect, account for and remit any tax imposed
by the NIRC, as amended, who willfully fails to collect such tax, or account for and
remit such tax or willfully assist in any manner to evade any payment thereof, shall
in addition to other penalties provided for in the Code, as amended, be liable, upon
conviction, to a penalty equal to the amount of the tax not collected nor accounted
for or remitted.
c) c. Any employer / withholding agent who fails, or refuses to refund excess
withholding tax not later than January 25 of the succeeding year shall, in addition
to any penalties provided in Title X of the Code, as amended, be liable to a penalty
equal to the total amount of refund which was not refunded to the employee
resulting from any excess of the amount withheld over the tax actually due on their
return.

2. Employee

Where an employee fails or refuses to file the Application or Certificate of Update of

Exemption and or Employer's and Employee's Information (BIR Form No. 2305) together
with the attachments or willfully supplies false or inaccurate information thereunder after
due written notice by the employer, the tax otherwise to be withheld by the employer shall
be collected from him including penalties or additions to the tax from the due date of
remittance until the date of payment.

On the other hand, where the employee, after due written notice from the employer, willfully
fails or refuses to file the said Application or Certificate, whichever is applicable, or willfully
supplies false and inaccurate information, excess taxes withheld by the employer shall not
be refunded to the employee but shall be forfeited in favor of the government.

PERSONS REQUIRED TO DEDUCT AND WITHHOLD

The following persons who are hereby constituted as withholding agents for purposes of

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the creditable taxes that are required to be withheld on income payments:

1. In general, any juridical person, whether or not engaged in business or trade;

2. An individual, with respect to payments made in connection with his trade or
business. However, insofar as taxable sale, exchange or transfer of real property is
concerned, individual buyers who are not engaged in trade or business are also
constituted as withholding agents;
3. All government offices including government-owned or controlled corporations, as
well as provincial, city and municipal governments.

NOTE: BIR Form 2316 (Certificate of Compensation Payment and Tax Withheld) shall be filed and
paid under BIR Form 1601C, Monthly Remittance Return on Income Taxes Withheld on
Compensation. This will already serve the purpose of BIR Form 1700 (Income Tax Return of
Employee) if this is the only source of income of the taxpayer.

REGISTRATION OF WITHHOLDING AGENT

Every person who makes payment or expects to make payment of compensation in an

amount exceeding the statutory minimum wage to any singe employee shall register by
filing in duplicate, with the RDO of the city or Municipality where his legal residence or place
of business is located, an Application for Registration as withholding agent using the form
prescribed by the BIR not later than 10 days after becoming an employer.

TIME OF WITHHOLDINGG

The obligation of the payor to deduct and withhold the tax under Section 25.7 of these
regulations arises at the time an income is paid or becomes payable, whichever comes first.
The term payable refers to the date the obligation becomes due, demandable or legally
enforceable.

WHERE AND WHEN TO FILE

Creditable and final withholding taxes deducted and withheld by the withholding agent shall
be paid upon filing a return induplicate with the authorized agent banks located within the
RDO having jurisdiction over the residence or principal place of business of the withholding
agent.

In places where there are no authorized agent banks, the return shall be filed directly with
the RDO, Collection Officer or the duly authorized Treasurer of the city or municipality
where the withholding agent's residence or principal place of business is located.

For both large and non-large taxpayers, the tax return, whether creditable or final shall be
filed and payments should be made within 10 days after the end of each month except for
taxes withheld for the months of December of each year, which shall be filed on or before
January 15 of the following year.

WITHHOLDING TAX STATEMENT

Every payer required to deduct and withhold taxes under these regulations shall furnish

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each payee, whether individual or corporate, with a withholding tax statement, using the
prescribed form showing the income payments made and the amount of taxes withheld
there from, for every month of the quarter (except Form 2316 for Compensation) within
twenty (20) days following the close of the taxable quarter employed by the payee in filing
his/ its quarterly income tax return. Upon request of the payee, however, the payor must
furnish such statement to the payee simultaneously with the income payment. For final
withholding taxes, the statement should be given to the payee on or before January 31 of
the succeeding year.

ANNUAL INFORMATION RETURN FOR INCOME TAX WITHHELD

The payor is required to file on or before January 31 of the following year. The Annual
Information Return of Income Tax Withheld at Source (Form No. 1604 E) should show
among others the following information:

1. Name, address and taxpayer's identification number (TIN);

2. Nature of income payments, gross amount and amount of tax withheld from each
payee and such other information as maybe required by the Commissioner.

If the payor is the Government of the Philippines or any political subdivision or agency
thereof, or any government-owned or controlled corporation, the return shall be made by
the officer or employee having control of the payments or by any designated officer or
employee.

Sources:

Llamado, C.P. & de Vera, J.L.A. (2019) – Philippine Income Tax Volume 1 (2019 Edition)
Naranjo, C.V.R. (2017) – General Principles of Taxation Review Material. SMARTS CPA Review, General Santos City
Rosada, F.U. (2018) – Notes in General Principles of Taxation Review Material. IRS CPA Review, Iloilo City and Leganes
Tabag, E.D. (2020) – Income Taxation. EDT Book Shop, Quezon City (2020 Edition)

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