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How to use salary sacrificing to reduce your tax

Compilation image of hands counting cash and tax- and tax+ buttons on a calculator
The key to a tax-effective salary sacrifice is for the employee to sacrifice some of their salary for benefits instead. (Source: Getty)

Salary sacrificing, or packaging, is when an employee arranges to sacrifice some of their salary in return for benefits.

It's a tax-effective agreement between the employer and employee and can have major advantages for both parties.

Employers can use it to attract new employees and it can also act as an incentive to increase productivity. Although employers need to consider the administrations costs.

Employees can benefit from pre-tax dollars and sometimes also dropping down a tax bracket to pay less overall tax.

Read more from Mark Chapman:

So are you planning to salary sacrifice? Here's everything you need to know about how it works, and what it means for your taxes.

What can I salary sacrifice?

The most common salary packaging items are:

  • Car fringe benefits (i.e Novated Lease)

  • Expense payment fringe benefits (incl. otherwise deductible)

  • Living away from home allowance fringe benefits

  • Car parking fringe benefits

  • Superannuation

Get an agreement in writing

You should always get an agreement in writing between you and your employer clearly stating all the terms of the salary sacrifice arrangement. This contract, although generally put in writing, can also be a verbal agreement. But, if you chose to enter into an undocumented salary sacrifice arrangement (verbal agreement), you risk having difficulties down the track.

Always make sure that an agreement is put in place between you and your employer before the work is performed. If the arrangement is put into place after the work has been performed, the salary sacrifice arrangement may be ineffective.

Salary sacrifice benefits: You're getting pre-tax dollars

The advantages of salary sacrifice are that you are buying the benefit in pre-tax dollars. That is, if your tax rate is 32.5 per cent, you get 32.5 per cent better buying power.

Here's an example:

John earns $130,000 a year and wants to buy a new work car worth $22,000. Had he entered into a salary sacrifice agreement with his employer, the $22,000 for the car would be taken out of his taxable income. This would give a double benefit of both getting a tax-free car and also pushing him into a lower tax bracket (thanks to his new $108,000 income).

But there are a few things to note before going down the route of salary sacrificing.

  • The calculations in the above example have not taken Fringe Benefits Tax (FBT) into account. Whether your employer pays the FBT and whether you reimburse your employer for the private use would also affect the calulation.

  • The private use of the car affects the FBT payable.

  • Some benevolent institutions do not 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.

Also, motor cars are subject to FBT but have concessional rates according to private use.

And expenses such as school fees, personal expenses and mortgage payments attract Fringe Benefit Tax which is based on the top marginal rate of tax.

What about fringe benefits tax-free items?

A number of benefits are exempt from FBT, including these work-related items commonly provided in salary sacrifice arrangements:

  • Portable electronic device

  • Computer software

  • Protective clothing

  • Briefcase

  • Tool of 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 item.

Note that the one item rule does not apply to small businesses (defined as those with a turnover less than $50 million). That means that multiple work-related items can be provided FBT free, for instance a phone and a laptop.

Can I get FBT on my salary sacrificed super contributions?

If salary sacrificed super contributions are made to a complying super fund, the sacrificed amount is not considered a fringe benefit for tax purposes.

The amount of the contribution will not be liable to FBT and the contributions will not be included as a reportable fringe benefit amount on the employee’s payment summary. Salary sacrificed contributions are treated as employer contributions.

As superannuation contributions are not subject to FBT and are not reportable benefits, they're an attractive option to salary package. The amount that is salary sacrificed is taxed in the superannuation fund at 15 per cent, which means an employee on 32.5 per cent marginal rate will save 17.5 per cent tax on every dollar that is salary sacrificed into super.

And an employee on higher marginal tax rates will have even higher savings.

Is there a concessional contributions cap?

Salary sacrificed contributions to a super fund form part of the ‘concessional contributions’ in the fund. Employer contributions made under the super guarantee also form part of an employee’s ‘concessional contributions’.

Concessional contributions are included in the assessable income of the fund and taxed at 15 per cent. But, there is a $27,000 cap on the amount of concessional contributions that each member can get for each financial year.

And you can't split up payments either - If a person has contributions made to more than one superannuation fund, all contributions are aggregated.

Looking for advice on salary sacrificing? H&R Block can help you out. Contact us today on 13 23 25 or visit us at an office close to you.

Mark Chapman is director of tax communications at H&R Block.

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