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Lesson 4

ITEMS OF GROSS INCOME

Lesson Objectives:

At the end of this lesson, the students should be able to:

a. Define gross and taxable income
b. Learn what are the items of the gross income in taxation
c. Apply, practice, solve, analyze, and evaluate problems relating to the inclusions in the gross
income

Discussion

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TAXABLE INCOME
The term taxable income means the pertinent items of gross income specified in the Code, less deductions, if
any, authorized for such type of income by the Code or other special laws.

MEANING OF INCOME
Broad sense Income means all wealth, which flows into the taxpayer’s hands other than as a mere return of capital
Judicial definition Income is the gain derived from labor, or from capital, or from both labor and capital, including the gain
derived from the sale or exchange of capital asset
Requisites of a taxable a. There must be gain
income b. The gain must be realized or received
c. The gain must not be excluded by law from taxation

GROSS INCOME
Except when otherwise provided, gross income means all income from whatever source, including (but not
limited to the following items):
a. Compensation for services in whatever form paid, including but not limited to fees, salaries, wages,
commissions, and similar items
b. Gross income derived from the conduct of trade or business or the exercise of a profession
c. Gains derived from dealing in property
d. Interests
e. Rents
f. Royalties
g. Dividends
h. Annuities
i. Prizes and winning
j. Pension
k. Partner’s distributive share from net income of the general professional partnership

COMPENSATION FOR PERSONAL SERVICES

Gross compensation income Gross compensation income means all remuneration for services performed by an employee for his
defined employer, whether paid in cash or in kind, unless specifically excluded under the Tax Code
Director’s fee Director’s fee is part of the gross compensation income if the director is at the time an employee of
the employer/corporation. If the director is not an employee, the director’s fee is subject to 5%
creditable withholding tax if the current year’s gross income is P3,000,000 and below (10% if
current year’s gross income exceed P3,000,000)
Compensation in the absence In absence of employer-employee relationship, compensation for personal services shall be
of employer-employee considered as gross professional fee
relationship
Examples of compensation for All kind of compensation for services rendered constitutes gross income. They include:
services rendered a. salaries, wages and fees
b. Commissions paid to salesmen
c. Compensation for services on the basis of a percentage of profits

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d. Commission on insurance premiums

e. Tips
f. Pensions or retiring allowances paid by private persons or by the government (except
pension exempt from tax)
g. Marriage fees, baptismal offerings, sums paid for saying masses for the dead, and other
contributions received by a clergyman, evangelist, or religious worker for services
rendered
Forms of compensation FORMS OF COMPENSATION TAXABLE AMOUNT
Payments made in cash Full amount received
Services paid for with something other than Fair market value (FMV) of the thing taken in
money (in kind) payment
Services rendered at a stipulated price In the absence of evidence to the contrary, the
stipulated price shall be presumed to be fair
market value
Examples of payment in kind PAYMENTS IN KIND TAXABLE AMOUNT
Compensation paid to an employee of a Fair market value of the stock at the time
corporation in its stock received by the employee
Promissory note and other evidence of Promissory note is not interest bearing
indebtedness in payment of services, and not Year received- fair discounted value
merely as security for such payment Year collected- face value less fair discounted
value
Promissory note is interest bearing
Year received- face value
Year collected- maturity value less face value

Gross Income Derived From the Conduct of Trade or Business, or the Exercise of Profession

Gross sales/receipts xxx

Less: sales returns and allowances xxx
Sales discount xxx xxx
Net sales/receipts xxx
Less: cost of sales/services xxx
Gross income from operation xxx
Add: other income xxx
Total gross income xxx

GAINS DERIVED FROM DEALINGS IN PROPERTY

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Property acquired by purchase on or after Selling price xxx

March 1, 1913 Less: cost xxx
gain xxx
Property acquired by inheritance Selling price xxx
Less: FMV, date of inheritance xxx
gain xxx
Property acquired by gift Selling price xxx
Less: value in the hands of the donor xxx
gain xxx

INTEREST INCOME
Included in interest Interest includes such interest arising from indebtedness, whether business or non-business. Unless
income exempted by law, interest by a taxpayer, whether or not usurious, are taxable
Subject to final tax Interest income from Philippine sources subject to final tax (not included in the taxable net income subject
to tax rates in general)
a. Interest from any currency bank deposit
b. Yield or any other monetary benefit from deposit substitute
c. Interest on government debt instrument and securities (regardless number of lender)
d. Yield or any other monetary benefit from trust funds and similar arrangements
e. Interest income received from a depositary bank under expanded foreign currency deposit system
f. Interest income from long-term deposit or investment evidenced by certificates prescribed by
Bangko Sentral ng Pilipinas if pre-terminated before fifth year or received by individual issued by
financial institution other than a bank
Subject to tax rates in a. Interest income from foreign sources
general b. Interest income from debt instrument not within the coverage of deposit substitute
c. Interest from long-term deposit or investment received by domestic and resident foreign
corporation
Exempt from income Interest income from Philippine sources exempt from tax:
tax a. Interest income received from a depositary bank under expanded foreign currency deposit system
by non-residents (individuals or corporations)
b. Interest income from long-term deposit or investments evidenced by certificates prescribed by
Bangko Sentral ng Pilipinas (issued by banks to individuals in P10,000 denomination)

RENT INCOME
1. Income of lessor under lease agreement
PAYMENTS MADE LESSOR LESSEE
Rent Income Expense
Obligation of lessor to third person paid by Income Expense
lessee
Advance rent Income in full in the year received Expense to be prorated over the period
regardless of accounting method used covered regardless of accounting method
Leasehold improvement Income reported under lump sum or Expense (depreciation) over the term of
annual method the lease or estimated life whichever is
shorter

2. Advance payment not representing rent

Loan Advance payment representing loan to the lessor is not taxable unless applied to unpaid rent

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Security deposit Advance payment representing security deposit is not taxable unless violation in the lease contract rises

3. Leasehold improvement
Additional income to the lessor Leasehold improvement is a source of additional income to the lessor if it shall become his upon
the expiration of the lease
Recognition of income from Lump sum or outright method- lessor may report as income, at the time when such buildings or
leasehold improvement improvements are completed, the fair market value (FMV) of such buildings or improvements
subject to the lease
Annual or spread out method
Cost of leasehold improvement xxx
Less: accumulated depreciation (remaining term of lease) xxx
Book value, end of lease xxx
Annual income
Book value, end of lease/remaining term of lease xxx
Computation of income resulting from premature termination of lease
FMV of improvement when lessor took possession xxx
Less: amount already reported as income xxx
Income, year of termination Xxx

Computation of loss due to Amount already reported as income xxx

destruction of leasehold Less: insurance recovery xxx
improvement before the term Salvage value xxx xxx
of the lease expires Loss xxx

Illustrative Problem

On July 1, 2016, Pedro leased his vacant lot for a period of 12 years to Juan at an annual rate of P2,400,000. It
was also agreed that Juan will pay the following in 2016:
 P4,800,00 representing rental payment for 2 years
 Security deposit of P2,400,000
 Annual real property tax of P30,000
The lease contract provides, among others that Juan will construct a 5-storey building for parking purposes at a
cost of P36,000,000. Ownership of the building shall belong to Pedro upon expiration or termination of the
lease contract. The building was completed on July 1, 2018 with an estimated useful life of 15 years.

Pedro’s total income from the lease in 2016 is

rental income for 2 years received in 2016 4,800,000
annual real property tax assumed by the lessee 30,000
income from leasehold improvement(not yet completed) -
lessor's taxable income in 2016 4,830,000

Pedro’s total income from the lease in 2017 is

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rental income received in 2017 -

2017 annual real property tax assumed by the lessee 30,000
income from leasehold improvement(not yet completed) -
lessor's taxable income in 2016 30,000

Assuming Pedro will use outright method in recognizing income from leasehold improvements, the total
income for the year 2018 is
rental income received in 2018 2,400,000
annual real property tax assumed by the lessee 30,000
income from leasehold improvement= cost of construction 36,000,000
lessor's annual income 38,430,000

Assuming Pedro will use spread-out method in recognizing income from leasehold improvements, the
total income for the year 2018 is
rental income received in 2018 - 2,400,000
annual real property tax assumed by the lessee - 30,000
income from leasehold improvement -
cost 36000000
x remaining life after lease term over total useful life 5/15
remaining book value after lease term 12000000
divide by remaining lease term (shorter) 10
annual income from leasehold improvement 1200000
x (allocated = July to Dec) 6/12
income from leasehold improvement (2018) - 600,000
Pedro's 2018 income - 3,030,000

Assuming that due to the fault of the lessee, the lease contract was terminated on January 1,2020, income
reported by the lessor in 2020 is

income from leasehold improvement

cost 36,000,000
x remaining life after termination over total useful life 13.5/15
remaining book value after termination 32,400,000

income from improvement already recognized

2018 (6 months) (600,000)
2019 (one year) (1,200,000)
remaining book value, Jan 1, 2020 30,600,000

ROYALTIES
1. Subject to final tax- royalties from Philippine sources

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2. Subject to tax rates in general- royalties from foreign sources

DIVIDEND INCOME (including shares in the net income of certain entities)

Difference between direct and A direct dividend is one where the paying corporation acknowledges that the distribution is a
indirect dividends dividend payment.
An indirect dividend is a distribution of profits disguised as payment of services, properties, etc.
Dividends/shares in net income a. Cash and/or property dividends actually or constructively received by individuals from
subject to final tax domestic corporation or from a joint stock company, insurance or mutual fund company
and regional operating headquarters of multinationals
b. Inter-corporate dividends received from domestic corporation by non-resident foreign
corporations
c. Share of an individual in the distributable net income after tax of a partnership (other
than a general professional partnership) of which he is a partner
d. Share of an individual in the net income after tax of an association, a joint account, or a
joint venture or consortium taxable as a corporation of which he is a member or co-
venturer
Dividends/shares in net income a. Dividends from forign corporations
subject to tax rates in general b. Share in the net income of a general professional partnership
Dividends that are exempt Inter-corporate received from domestic corporation by other domestic corporation and resident
from tax foreign corporation

ANNUITIES
An annuity is a specified income payable at stated intervals for a fixed or a contingent period, often for the
recipient’s life, in consideration of a stipulated premium paid either in prior installment payments or in a single
payment.
1. Non-taxable annuity- annuity representing return of premium
2. Taxable annuity- excess of the amount returned as premium

PRIZES AND WINNINGS

Subject to tax rates in a. Prizes and winnings from foreign sources received by individuals and corporations
general b. Prizes and winning from Philippine sources received by corporations
c. Prizes from Philippine sources received by individuals amounting to P10,000 or less
Subject to final tax a. Prizes received by individuals from Philippine sources except prizes amounting to P10,000 or
less which shall be subject to tax under Sec. 24 (A)
b. Other winnings of individuals from Philippine sources (except Philippine Charity Sweepstakes
and Lotto winnings amounting to P10,000 or less which shall be exempt)
Exempt/excluded from a. Philippine Charity Sweepstakes and Lotto winning amounting to P10,000 or less
gross income b. Prizes and award made primarily in recognition of achievement in religious, charitable,
scientific, educational, artistic, literary, or civic field given that the recipient was selected without
any action on his part to enter the contest or proceedings or the recipient is not required to render
substantial future services as a condition to receiving the prize or award
c. All prizes and awards granted to the athletes to local and international sports competitions and
tournaments whether held in the Philippines or abroad and sanctioned by their national sports
association

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Summary of the Lesson

The lesson defined what is the gross income and taxable income in taxation. It also discussed the items included
for the computation of the gross income. The lesson focused also in illustrating the application and evaluation of
problems relating to inclusions to gross income.

Enrichment Activity

Choose the letter of the correct answer.

1. Which of the following is a requisite for an income to be taxable?

a. There must be a gain
b. The gain must be realized or received
c. The gain must not be excluded by law from taxation
d. All of the above

2. Which of the following is not a characteristic of income?

a. Increase in taxpayer’s wealth
b. Realization or receipt of gain
c. Earnings constructively received
d. Return of taxpayer’s wealth

3. Which of the following compensation will be subject to graduated rate?

a. Basic salary whether or not the employee is a minimum wage earner
b. Basic salary only if the employee is not a minimum wage earner
c. 13th month pay and other benefits not exceeding P30,000
d. Fringe benefits received by supervisory or managerial employee

4. The maternity leave pay under RA 11210, otherwise known as the 105 Day Expanded Maternity Leave
law, shall be:
a. Exempt from tax
b. Subject to graduated income tax rate
c. Subject to fringe benefit tax

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d. The actual cash benefit from SSS is exempt while the salary differential shouldered by the employer
shall be treated as compensation income subject to graduated income tax rate
5. One of the following income shall be returned in the year received.
a. Interest earned ion bank deposit
b. Share in net income of professional partnership
c. Stock dividend
d. Rentals for 2018, 2019, and 2020 received in 2018 by a lessor under accrual method

6. If a corporation distributes it own treasury stocks to its stockholders, this kind of a corporate distribution
which is recognized in the Tax Code is a:
a. Stock dividend
b. Property dividend
c. Cash dividend
d. Liquidating dividend

7. Liquidating dividends are return of shareholders’ investment. Which of the following rules on
liquidating dividend is incorrect?
a. The excess amount of liquidating dividend over cost of shares surrendered is taxable
b. If a shareholder sustains a loss brought about by the liquidating dividend, such loss is deductible
c. If a shareholder sustains a loss brought about by the liquidating dividend, such loss is not deductible
d. All of the above
8. Annuity payments received by a taxpayer represent a part which is taxable and not taxable. Which of the
following statement is correct?
a. If annuity received represents interest, it is a taxable income
b. If annuity received represents return of premium, it is not a taxable income
c. Both statements are correct
d. Both statements are not correct

9. Prizes and awards received shall be exempt from income tax when the following conditions are met
except
a. It is given in recognition of religious, charitable, scientific, educational, artistic, literary or civic
achievement
b. The recipient of the ward or prize is not required to render substantial future services as a condition
in receiving the prize or award
c. The recipient of the award was selected without any action on his part to enter the contest or
proceeding
d. The amount of prizes does not exceed P10,000

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10. This refers to a specified income payable at stated intervals for a fixed or a contingent period, often for
the recipient’s life, inconsideration of a stipulated premium paid either in prior installment payments or
in a single payment
a. Annuity
b. Royalty
c. Pension
d. Gratuity

Assessment
Compute what is being asked in every problem and provide supporting solutions in the back or excess space in
this module.

Problem 1
Juana, widow received the following during 2018:
 Received $500 ($1=P44) monthly interest income from the pension plan of his deceased husband who
served in the US Army for 20 years
 Won a beauty contest “Miss Byuda 2018”. She \received the following as prizes:
Cash prize, P50,000
Free-trip abroad worth P50,000
College scholarship with International College of Business and Economics worth P100,000
Goods worth P20,000
 P100,000 from her debtor in payment of a loan, and interest in the sum of P15,000
 Inherited from her grandmother a lot and apartment valued at P2,500,000 from which she is receiving
monthly rental of P15,000

1. The income subject to tax is

a. P 415,000
b. P679,000
c. P250,000
d. P515,000

Problem 2
Mike leased his land to Leomar for 2 years beginning JJuly 1, 2018. Leomar would pay monthly rental of
P100,000. He paid rent up to October 2018 and then defaulted for the rest of the year.

2. Under accrual method, how much was the income of Mike for 2018?
a. P200,000
b. P400,000

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c. P600,000
d. None of the choice

3. How much was the income of Mike in 2018 using cash method?
a. P200,000
b. P400,000
c. P600,000
d. None of the choices

4. Under accrual method, how much was the deductible expense of Leomar in 2018?
a. P600,000
b. P400,000
c. P200,000
d. None of the choices

5. Under cash method, how much was the deductible expense of Leomar in 2018?
a. P600,000
b. P400,000
c. P200,000
d. None of the choices

Problem 3
On January 1, 2017, Cathrina leased her land to Leah. The terms of the contract of lease is for 15 years and the
rental fee is P360,000 a year. The contract provides that Leah will construct a building and at the end of the
term of the contract, the ownership of the building will be transferred to Cathrina. The building, with useful life
of 30 years, was completed on January 1, 2018 at a cost of P6,000,000.
6. Assume Cathrina will spread her income over the term of the contract of lease, for income tax purposes,
Cathrina’s 2018 income is:
a. P360,000
b. P560,000
c. P760,000
d. P6,360,000

7. Assume Cathrina opted to use the lump sum method of recognizing income from leasehold
improvements, her taxable income in 2018 should be:
a. P360,000
b. P560,000
c. P760,000

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d. P6,360,000

8. Using the assumption in the immediately preceding number, Cathrina’s taxable income in 2019 should
be:
a. P360,000
b. P560,000
c. P760,000
d. P6,360,000

Problem 4
Brian is an amateur boxer who represented the Philippine team in the recently concluded Rio Olympics held in
Brazil. For winning in the said competition, he received the following amounts:
 P500,000, cash prize from the Amateur Boxing Association of the Philippines (accredited national
sports association)
 P2,000,000 cash award donated by Rizal Commercial Banking Corporation (RCBC)
 P600,000 talent fee as model of a known boxing gear
 P900,000 professional fee from ABS-CBN for being an instant celebrity

9. How much of the above amounts is taxable to Brian?

a. P0
b. P1,500,000
c. P2,000,000
d. P4,000,000
Problem 5
JJ, a member of the Philippine boxing team received the following during 2018:

Prize for winning gold in the Asian games 500,000

Athlete of the year award 100,000
Winnings from Philippine Lotto 40,000
Prize- McDonald raffle promo 10,000
Cash gift from SM Foundation 100,000
10. The amount not subject to income tax is:

a. P700,000
b. P1,100,000
c. P1,110,000
d. P1,010,000

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References:

SIA, TABAG & REYES (2018). Gross Income. Taxation. Excel Professional Services, Inc.
TAMAYO, LIM, CAIGA & MANUEL (2019). Income Tax (Items of Gross Income). Taxation. The Review
School of Accountancy
TABAG, E (2020). Gross Income. CPA Reviewer in Taxation with Special Topics and Properly Filled BIR
Form. EDT Bookshop

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