Friday, 13 July 2012

Tax time: How does salary sacrificing work?

This post will go through how salary sacrificing works and how you may be able to save significant amounts of money on large purchases if you employer lets you enter into these schemes.  Please note that this is for Australian tax payers only (I have no idea if this system is applicable anywhere else in the world). 

The most complete source of information is the Australian Tax Office website so I'd visit there as well but as they do not really simplify the issue I thought I would summarise it here.

What is salary sacrificing?

Broadly speaking it is entering into an arrangement with your employer whereby you forgo part of your salary for a product / service / good that is provided to you.  The most commonly used example is an arrangement of cars:
  • You enter a lease agreement for a car which your employer pays for
  • This includes all maintenance, insurance, petrol etc
  • This is paid out of pre-tax dollars
  • Your employer has to pay fringe benefits tax for this service provided to you
  • The fringe benefits tax is normally also taken out of your pay
Why would I use salary sacrificing - shouldn't I just purchase or lease the car myself?

The benefit you get is because of the different tax treatments for income tax and fringe benefit tax.  It would be worth your while entering into the salary sacrifice agreement if your marginal tax rate is above the fringe benefits tax rate.  For cars the FBT rate is currently 20% which means if your marginal tax rate is above 20% you can save money by entering into this kind of arrangement.  It varies between different classes of benefits so is always best to check it out before entering into an arrangement.

Note that on some products there is no fringe benefits tax payable.  These are the products that are really good from a salary sacrificing point of view.  They include things like portable electronic devices, security, work clothes and tools. 

How do I enter into a salary sacrificing arrangement?

The first thing to do is talk to your employer.  Not all employers offer it unfortunately.  If you do enter into an arrangement make sure you adhere to the following:
  • Make sure the arrangement is in writing - it doesn't technically have to be but if the ATO asks you to prove it later it is pretty hard if it is a verbal agreement
  • The agreement needs to be for future services you provide - you unfortunately cannot enter into retrospective arrangements
  • The salary you forgo needs to be forgone for the entire period of the arrangement - for a car this means for the entire time your firm is paying your lease payments and other costs
What should you watch out for in salary sacrificing arrangements?

Reportable fringe benefits - if the grossed up value of the benefit you are getting (i.e. the value divided by your marginal tax rate) is greater than $2000 then this gets reported on your tax statement.  This does not make any difference to your income tax but you will have to pay a higher medicare levy and it impacts the rate at which you have to repay your student HELP loans.

You can elect to contribute part of the payment (normally an amount equal to the FBT the employer would usually have to pay) - this actually saves you a fair bit of money because you actually lose less money to your employer.  The best example is the one provided by the ATO.

What products can I use it on?

There is no restriction on the products.  It is normally used for large purchases including cars and property.  It is also a fairly common way of contributing to your superannuation (see my previous posts on salary sacrificing into super).  There are special rules for superannuation.

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