Salary sacrifice arrangements, also known as salary packaging, can be a smart way to get ahead, but it can also get confusing. Essentially, salary sacrificing means you use a portion of your pre-tax income in exchange for certain benefits or items. And, as you use your pre-tax income, you pay less tax overall. Many employers offer salary sacrificing arrangements that allow employees to contribute additional money to their superannuation, or to purchase a car for work purposes. These agreements can also be used for purchasing other items including phones, laptops, and even (on rare occasions) your mortgage!
Salary Sacrificing Example:
You earn $6,000 per month and you make a salary sacrifice arrangement with your employer to contribute an additional $300 per month to your superannuation. While you give your super a boost for retirement, you also benefit in the short term as you only pay tax on $5,700 of income instead of $6,000. Annually, this means that on your annual salary of $72,000, you’re only paying tax on $68,400.
How does salary sacrifice work?
First, you need to set up a salary sacrifice arrangement with your employer. This agreement can either be written directly into your employment contract or agreed separately. Regardless, it should always be in writing, so the terms of the arrangement are clearly stated and agreed upon.
It is not compulsory for an employer in Australia to offer salary packaging to their employees. Due to the complexity and administrative costs, some employers will limit employees’ access to salary sacrificing. On the other hand, others may use it as a perk to attract and retain employees.
What can I salary sacrifice?
There are three main items (or benefits) that employers usually offer as part of a salary sacrifice agreement:
Fringe benefits are non-cash benefits provided by an employer to their employees or their associates (e.g. spouse, dependent children) in addition to their regular salary or wages. These are often big-ticket items and can also include recurring expense payments. While some employers use these as a perk, many do not offer them at all because fringe benefits are taxed under the fringe benefits tax (FBT) system, which requires the employer to pay tax on the value of fringe benefits provided to their employees.
There are several benefits that your employer won’t have to pay fringe benefits tax (FBT) on. These include items like electronic devices, computer software, clothing or other tools of the trade. Exempt items must be primarily for work use and are limited to one per year unless it’s a replacement item.
One of the most popular salary sacrifice options offered by employers is extra superannuation contributions. What that means is, you can put extra money into your super savings, and pay much less tax on it. To do this, you have to arrange it with your employer before the start of a financial year.
Similarly, you can make an after-tax ‘manual’ contribution to your super fund, then claim a tax deduction later on, which means you paid less tax on that money. That’s an option if you miss out on the timing to set up a proper superannuation salary sacrifice with your employer. If you do this, it’s a good idea to talk to a financial advisor and your tax agent.
What does this mean at tax time?
With a salary sacrifice agreement in place, your income would have been reduced, and therefore you would have paid less tax out of your wages.
While you don’t pay tax on fringe benefits and superannuation contributions, you have to include them on your tax return. This is for the purpose of calculating your eligibility to other government levies or payments.
Let’s use the example of someone whose employment contract states their role is worth $95,000 per year and they salary sacrifice $7,000 per year, making their taxable income $88,000 per year. The ATO uses the value of the taxable income, plus the salary sacrifice amount together to calculate whether the Medicare levy surcharge (which kicks in at $90,000) applies. In this case, as the taxable income, plus salary sacrifice equals $95,000, the Medicare levy surcharge would apply if this taxpayer did not have appropriate private hospital cover.
It’s always best to consult with a tax professional, like Etax to fully understand the implications of entering into a salary sacrifice arrangement.