Withholding tax on compensation is the income tax that an employer is required to deduct and withhold from the salaries and wages of employees, and remit to the Bureau of Internal Revenue on the employee's behalf. This is a pay-as-you-earn system: instead of the employee paying their entire income tax at year-end, the tax is collected gradually from each payroll. The amount withheld depends on the employee's compensation and the withholding tax tables. Under the TRAIN law, employees earning not more than the tax-exempt threshold (an annual taxable income of two hundred fifty thousand pesos) are effectively not subject to income tax, so no tax is withheld from them, and the graduated rates apply above that. Certain benefits, such as the 13th month pay and other benefits up to a ceiling, mandatory contributions (SSS, PhilHealth, Pag-IBIG), and de minimis benefits, are excluded from taxable compensation. At year-end, the employer performs an annualization (year-end adjustment) to reconcile the total tax withheld against the actual tax due, refunding any over-withholding or collecting any shortfall. A qualified employee whose tax has been correctly withheld may be subject to substituted filing, meaning the employer's annual information return serves as the employee's income tax return.
Pay-As-You-Earn
Withholding tax on compensation is income tax the employer deducts from wages and remits to the BIR — a pay-as-you-earn system collected each payroll.
The Exempt Threshold
Under TRAIN, employees earning not more than the P250,000 annual taxable income are effectively not subject to income tax, with graduated rates above that. 13th month pay (up to a ceiling), mandatory contributions, and de minimis benefits are excluded.
Year-End Adjustment
At year-end, the employer annualizes to reconcile withheld tax against actual tax due, refunding over-withholding or collecting any shortfall. A qualified employee may be under substituted filing (no separate return).
Practical Takeaways
- Employers withhold income tax from wages and remit to the BIR;
- Up to P250,000 taxable income is effectively tax-free;
- A year-end annualization refunds over-withholding — and substituted filing may apply.
Frequently Asked Questions
What is withholding tax on compensation? The income tax an employer deducts from employees' salaries and remits to the BIR on their behalf, under a pay-as-you-earn system that collects the tax gradually each payroll.
Is there income exempt from tax? Yes. Under the TRAIN law, employees earning not more than P250,000 in annual taxable income are effectively not subject to income tax, with graduated rates applying above that.
What is the year-end adjustment? An annualization the employer performs at year-end to reconcile the total tax withheld against the actual tax due, refunding any over-withholding or collecting any shortfall.
What is substituted filing? An arrangement where a qualified employee whose tax has been correctly withheld does not file a separate income tax return, because the employer's annual information return serves as the employee's return.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
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