What Is Salary Sacrifice?
Salary sacrifice is an arrangement between you and your employer which enables you to pay for certain goods or services straight from your pre-tax salary. The effect is to reduce your taxable income and hence reduce your tax bill, whilst giving you tax effective access to a variety of goods and services.
Salary sacrifice enables an employee to receive a combination of income and benefits to their tax. Effective salary sacrifice allows employees to take some of their remuneration in the form of concessionally taxed benefits instead of taking it all as fully assessable salary. This process gets its name due to the employee sacrificing some part of their salary in return for the desired benefits. To help you make the most of salary sacrificing, we’ve put together this comprehensive guide.
How to salary sacrifice
To salary sacrifice, both employer and employee need to be in agreement. For the employer, there are some advantages, such as the ability to attract employees. It can also act as an incentive to increase productivity, however, administration costs need to be considered. Because of these variables, some employers only offer limited forms of salary sacrificing. To know if salary sacrificing is an option, ask your employer.
What can I salary sacrifice?
While there are few limits on what can be salary sacrificed, fringe benefits tax (FBT) can impact on the type of items employers are prepared to offer. FBT is paid by employers and they’ll often look to pass these costs on to the employee. This has the effect of equalising your pre-tax and post-tax salary, hence removing some of the financial benefits. While there’s no restriction on what can be sacrificed, the benefits fall into three categories: fringe benefits, exempt benefits and super.
These can include:
- Health insurance
- Loans (usually for a car)
- School fees
- Childcare fees
- Other personal expenses
The value of the benefits received each financial year will appear on your payment summary at tax time and you won’t have to pay tax or Medicare levy on this amount. There are also benefits such as entertainment and car parking that won’t appear on your end of year payment summary. These are called non-reportable fringe benefits.
Some benefits are exempt from fringe benefits tax (FBT), including these work-related items commonly provided in salary sacrifice arrangements:
- Portable electronic devices
- Computer software
- Protective clothing
- Tools of the trade
The work-related items exemption is limited to:
- Items primarily for work-related use
- One item per FBT year for items that have a substantially identical function, unless the item is a replacement.
- Note that the one item rule doesn’t apply to small businesses – those with a turnover less than $10 million from 1 July 2016. Multiple work-related items can be provided FBT free, for instance, a phone and a laptop.
How to arrange a salary sacrifice
Make a salary sacrifice agreement with your employer. The agreement will need to be in place before the work commences; if the agreement is put in place after you’ve started working, it may be ineffective. Put your salary sacrifice arrangement in writing, clearly stating all the terms. Although generally put in writing, this contract may also take verbal form. However, if you chose to enter into an undocumented salary sacrifice arrangement (verbal agreement), you may have difficulty establishing the facts of your agreement.
You must permanently forego the sacrificed salary for the period of your arrangement. If a fringe benefit hasn’t been provided and is cashed out at the end of an accounting period, the amount cashed out is salary and is taxed as normal income.
What are the benefits of a salary sacrifice?
Salary sacrifice allows you to buy the benefit in pre-tax dollars. This means, if your tax rate is 32.5%, you get 32.5% better buying power. Say an individual earns $100,000 a year and wants to buy a new work-related car, worth $22,000. Had they entered into a salary sacrifice agreement with their employer, the $22,000 for the car would be taken out of their pre-tax income, putting them in the lower tax bracket with a $78,000 income and a tax-free car.
The above calculations haven’t taken into account Fringe Benefits Tax (FBT) as this depends on a few factors:
- Does your employer pay the FBT?
- Do you reimburse your employer for the private use?
- The private use of the car affects the FBT payable
- Some benevolent institutions don’t pay FBT
- FBT is payable by the employer, not the employee
- Many salary package deals require the employee to reimburse the employer for the FBT costs out of the salary package
Expenses such as school fees, personal expenses and mortgage payments attract Fringe Benefits Tax which is based on the top marginal rate of tax.
Salary sacrificing a car
This is one of the smartest ways to finance and purchase your new car. The amount used to pay the lease back comes directly from your salary and deductions will happen before the final calculation of your tax. This reduces your taxable income and results in a reduced tax bill for you.
By ‘sacrificing’ part of your salary each month to finance the car, you’re reducing your taxable income and saving money. You can also reduce the Fringe Benefits Tax (FBT) paid against your purchase by making contributions to the operating costs of the vehicle with post-tax income.
Salary sacrificing childcare fees
If you’re working and need paid care for your kids, you might be able to salary sacrifice the fees, so long as the childcare facility is a registered provider. This provider may be a privately owned facility, run by the local council or operated by your employer. Salary sacrificing childcare fees can affect your entitlement to government benefits so make sure you get advice before you commit. Childcare fees are also subject to FBT, which can reduce the benefit to the employee.
Salary sacrificing into super
This involves asking your employer to redirect a portion of your pay as a contribution to super. By 'sacrificing' some of your before-tax salary and putting it into your super fund, you get taxed at the special rate of 15%. This is a good opportunity for higher income earners due to their higher marginal tax rate.
It’s important to note that if salary sacrificed super contributions are made to a complying super fund, the sacrificed amount isn’t subject to FBT. This makes an attractive addition to any salary package; let’s say an employee has a 30% marginal rate – they’ll save 15% tax on every dollar that’s salary sacrificed into super. The higher your marginal tax rate, the bigger the tax savings.
Concessional contributions cap
If you salary sacrifice contributions to your super fund, this is treated as a ‘concessional contribution.’ Employer contributions made under the super guarantee also form part of an employee’s ‘concessional contributions’. These contributions are included in the assessable income of the fund and taxed at 15%. However, there’s a cap on the amount of concessional contributions each member can make each income year. If a person has made contributions to more than one superannuation fund, all contributions are aggregated.
From 1 July 2017, the amount of concessional contributions you can make is limited to $25,000
Exceeding the concessional contributions cap
If you exceed the concessional contributions cap, any excess concessional contributions are included in your assessable income for the corresponding year and taxed at your marginal tax rate. You are also liable to pay the excess concessional contributions (ECC) charge.
If the concessional contributions cap is exceeded and your calculated tax liability for the year includes the excess contributions, the ATO then applies a 15% tax offset which takes into account that contributions tax has already been paid on the excess by the super fund provider.
The ATO also allows for a withdrawal of up to 85% of the excess concessional contributions from the superannuation fund which can be used to pay the tax liability arising from excess contributions. Any further contributions withdrawn from the fund will no longer count towards your non-concessional contributions cap.
H&R Block can help
It’s important to take advice before rushing into salary sacrifice. We can help out with advice as well as running you through your options and crunching the numbers to ensure it’s right for you. Contact us today on 13 23 25 or visit us at your local H&R Block office.