One Person Corporation vs. Individual Proprietorship: Which Is Better for Taxes? A Comparative Analysis of Income and Estate Tax Considerations in the Philippines

Introduction

In the Philippine business landscape, entrepreneurs often face the choice between operating as an individual (typically through a sole proprietorship) or incorporating as a One Person Corporation (OPC). This decision carries significant tax implications, particularly in the realms of income taxation and estate taxation. The OPC, introduced under Republic Act No. 11232 (the Revised Corporation Code of the Philippines) in 2019, allows a single natural person to form a corporation with limited liability, blending the simplicity of sole ownership with corporate benefits. In contrast, an individual proprietorship involves direct personal ownership of business assets and operations, subjecting the owner to unlimited liability.

This article provides a comprehensive examination of the tax advantages and disadvantages of each structure, with a primary focus on income taxes (often referred to as personal taxes for individuals) and estate taxes. It explores how these entities are taxed under key laws such as the National Internal Revenue Code (NIRC) of 1997, as amended by the Tax Reform for Acceleration and Inclusion (TRAIN) Law (RA 10963) and the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law (RA 11534). Other relevant taxes, such as value-added tax (VAT), withholding taxes, and business taxes, are also discussed to offer a holistic view. The analysis assumes standard scenarios and emphasizes that tax outcomes can vary based on specific circumstances, necessitating consultation with a tax professional.

Overview of Business Structures

One Person Corporation (OPC)

An OPC is a corporation with a single stockholder who serves as the sole director, president, treasurer, and corporate secretary (unless otherwise designated). It must include "OPC" in its name and is registered with the Securities and Exchange Commission (SEC). Key features include:

Limited liability: The stockholder's personal assets are protected from corporate debts.
Perpetual succession: The entity continues beyond the stockholder's death.
Separate legal personality: The OPC is treated as a distinct entity for tax and legal purposes.
Minimum capital: No minimum paid-up capital requirement, though certain industries may impose thresholds.

Individual Proprietorship

A sole proprietorship is not a separate legal entity; it is an extension of the individual owner. Registration is with the Department of Trade and Industry (DTI) for the business name and the Bureau of Internal Revenue (BIR) for tax purposes. Characteristics include:

Unlimited liability: The owner is personally liable for all business obligations.
Simplicity: Easier setup with fewer regulatory requirements.
Direct control: All profits and losses flow directly to the owner.
Termination upon death: The business ceases or requires estate settlement.

The choice between these structures influences tax treatment, as corporations like OPCs are subject to corporate tax rules, while proprietorships follow individual tax regimes.

Income Tax Considerations

Income taxation forms the core of "personal tax" comparisons, as it directly affects the owner's take-home earnings. The Philippine tax system distinguishes between individual and corporate taxpayers, leading to divergent rates, deductions, and compliance obligations.

Income Tax for Individual Proprietorships

Taxpayer Status: The owner is classified as a self-employed individual or professional under Section 24 of the NIRC. Business income is aggregated with other personal income sources.
Tax Rates: Progressive rates apply, ranging from 0% to 35% based on taxable income brackets (as updated by TRAIN Law):
- 0% for annual taxable income up to PHP 250,000.
- 20% on excess over PHP 250,000 up to PHP 400,000.
- 25% on excess over PHP 400,000 up to PHP 800,000.
- 30% on excess over PHP 800,000 up to PHP 2,000,000.
- 32% on excess over PHP 2,000,000 up to PHP 8,000,000.
- 35% on excess over PHP 8,000,000.
Deductions and Credits: Owners can opt for:
- Itemized deductions (actual business expenses) or the Optional Standard Deduction (OSD) of 40% of gross sales/receipts.
- Personal exemptions are no longer available post-TRAIN, but additional deductions for health insurance premiums (up to PHP 2,400 annually) apply.
- Credits for taxes withheld at source or foreign tax credits.
Compliance: Quarterly income tax returns (BIR Form 1701Q) and annual returns (BIR Form 1701) are required. Minimum Corporate Income Tax (MCIT) does not apply.
Advantages: Lower effective rates for small incomes; direct pass-through of losses to offset personal income.
Disadvantages: Higher marginal rates for high earners (up to 35%); no salary deduction for the owner, as all income is personal.

Income Tax for One Person Corporations

Taxpayer Status: An OPC is treated as a domestic corporation under Section 22 of the NIRC, separate from the stockholder.
Tax Rates: Under CREATE Law (effective 2021):
- 20% regular corporate income tax (RCIT) for corporations with net taxable income not exceeding PHP 5 million and total assets not exceeding PHP 100 million.
- 25% RCIT for larger corporations.
- MCIT of 1% of gross income (reduced from 2% post-CREATE) applies if lower than RCIT, starting from the fourth year of operation.
Deductions and Credits:
- Actual business expenses are deductible, including salaries paid to the stockholder (subject to reasonableness under Section 34(A)(1)).
- No OSD option; must use itemized deductions.
- Dividends paid to the stockholder are subject to 10% final withholding tax if the recipient is a resident citizen.
Compliance: Quarterly (BIR Form 1702Q) and annual corporate income tax returns (BIR Form 1702) are filed. The stockholder files a separate personal return for dividends or salaries received.
Advantages: Lower flat rates (20-25%) compared to individual top rates; ability to deduct stockholder's salary as a business expense, reducing corporate taxable income; potential for income splitting (e.g., salary + dividends).
Disadvantages: Double taxation—corporate tax on profits, then personal tax on distributions; MCIT may apply even in loss years.

Comparative Analysis for Income Taxes

For Low-Income Businesses: Individual proprietorships may be preferable due to the 0% rate on the first PHP 250,000 and OSD simplicity.
For High-Income Businesses: OPCs often yield tax savings via lower corporate rates and salary deductions. For example, a business earning PHP 10 million net might face 35% individual tax (approx. PHP 3.5 million liability) vs. 25% corporate tax (PHP 2.5 million), plus 10% on dividends.
Break-Even Point: Generally, businesses with taxable income above PHP 2-3 million benefit more from OPC due to rate differentials.
Other Factors: OPCs allow retention of earnings without immediate personal tax, aiding reinvestment. However, individuals can defer taxes via retirement plans, unavailable to corporations.

Estate Tax Considerations

Estate taxation arises upon the owner's death, taxing the transfer of assets to heirs. The structure affects valuation, inclusion, and settlement processes.

Estate Tax for Individual Proprietorships

Applicability: Under Section 84 of the NIRC (as amended by TRAIN), estate tax is imposed on the net estate at a flat 6% rate on values exceeding PHP 5 million (no tax below this threshold).
Inclusion of Assets: All business assets (inventory, equipment, real property) are part of the personal estate, valued at fair market value (FMV) at death.
Deductions: Standard deduction of PHP 5 million, plus actual funeral expenses (up to PHP 200,000), judicial expenses, claims against the estate, and family home allowance (up to PHP 10 million).
Process: The estate is settled through probate or extrajudicial settlement. Business operations may halt during settlement, causing disruptions.
Advantages: Simpler inclusion; potential for lower valuation if assets are not appreciating rapidly.
Disadvantages: Unlimited liability extends to heirs if debts exceed assets; full FMV taxation without corporate shields.

Estate Tax for One Person Corporations

Applicability: The OPC itself does not pay estate tax, as it has perpetual existence. Instead, the stockholder's shares in the OPC are included in their personal estate, taxed at 6% on net value over PHP 5 million.
Valuation: Shares are valued based on the OPC's net asset value (book value or FMV of underlying assets minus liabilities). BIR may require appraisal.
Deductions: Same as for individuals, applied to the stockholder's estate.
Process: Upon death, the single stockholder's nominee (designated in the Articles of Incorporation) assumes management temporarily. Shares transfer to heirs via estate settlement, but the OPC continues operating seamlessly.
Advantages: Business continuity without interruption; potential undervaluation of shares if corporate debts reduce net worth; limited liability protects heirs from business debts.
Disadvantages: Complex valuation (e.g., goodwill or intangibles); possible donor's tax if shares were gifted pre-death; administrative hurdles in transferring control.

Comparative Analysis for Estate Taxes

Tax Liability: Often similar in quantum, as both tax FMV of assets/shares. However, OPCs may reduce effective tax through debt leveraging (deductible liabilities) or by holding appreciating assets corporately.
Planning Opportunities: OPCs facilitate estate planning via share transfers (e.g., gradual gifting subject to 6% donor's tax) or trusts. Individuals can use life insurance or joint ownership, but lack corporate perpetuity.
Risks: For high-value estates, OPCs minimize disruption but may attract BIR scrutiny on share valuation. Proprietorships risk forced asset sales to pay taxes.

Other Tax Considerations

While the focus is on income and estate taxes, other levies influence the overall decision:

Value-Added Tax (VAT): Both structures are subject to 12% VAT on gross sales exceeding PHP 3 million annually (threshold under TRAIN). Non-VAT taxpayers pay 3% percentage tax. OPCs may have better input VAT crediting due to corporate status.
Withholding Taxes: OPCs must withhold on payments (e.g., 5-10% on professional fees), while individuals do so only if classified as top withholding agents.
Local Business Taxes: Vary by locality but generally based on gross receipts; no major differences.
Capital Gains Tax (CGT): On asset sales—6% on real property FMV for both; 15% on shares for OPC stockholders (if unlisted).
Documentary Stamp Tax (DST): Applies to share issuances/transfers in OPCs; minimal for proprietorships.
Fringe Benefits Tax: OPCs pay 35% on employee benefits (including stockholder's), grossed-up.

Advantages and Disadvantages Summary

Advantages of OPC for Taxes

Lower income tax rates for profitable businesses.
Income splitting and deferral.
Business continuity and liability protection in estate scenarios.
Better for long-term wealth building.

Disadvantages of OPC

Double taxation on distributions.
Higher compliance costs (SEC filings, audits for larger entities).
Complex estate valuation.

Advantages of Individual Proprietorship

Simpler taxation and lower setup costs.
Direct loss offsets.
No double taxation.
Easier dissolution.

Disadvantages of Individual

Higher marginal income rates.
Unlimited liability exposing estate.
Operational disruptions upon death.

Conclusion

Choosing between an OPC and an individual proprietorship hinges on income levels, risk tolerance, and succession planning. For tax optimization, OPCs generally outperform for larger operations due to favorable corporate rates and estate continuity, while proprietorships suit smaller, low-risk ventures. However, the "better" option depends on holistic factors beyond taxes, such as regulatory compliance and business goals. Tax laws evolve, so periodic review and professional advice are essential to maximize benefits under the Philippine framework.