We’ve already spoken about how the primary goal of salary packaging is to reduce tax. But how does that actually happen?
The key idea is that the amounts taken from your pay and sent to the salary packaging provider account are taken from your gross (pre-tax) pay. This reduces your taxable pay, and consequently you pay less tax.
By comparing two payslips, we can see the effect that salary packaging has on taxable income and compare the total amount of tax paid when the employee earns an almost identical gross pay.
The first payslip has a gross pay of $2661 (1). After deducting a salary package that includes standard goods and services, meal entertainment, employer fees and salary packaging provider fees to a value of $2075 (3), it leaves us with a taxable income of $583 for the fortnight (2).
No tax is payable on this taxable income – it’s equivalent to an annual income of $12,000, well below the tax free threshold.
The second payslip has a gross pay of $2661 (1). This time around, we’ve used up all our salary packaging allowance and are now only salary packaging meal entertainment (3). Our taxable income is $2448 for the fortnight (2).
We now have to pay $520 in tax (4) and $110 of HECS! If extrapolated to a yearly basis, that’s $16,000 of tax and HECS each year!
As you can see, by reducing your pre-tax income salary packaging reduces the amount of tax you pay each fortnight. Spread through a year, the disparity shown in the example above is much less.
It would be wonderful if we could package our entire pay, but unfortunately there are limits and these limits are related to Fringe Benefits Tax – I’ll explain more in our next post.