With the rising cost of living, many contractors seek ways to optimise their earnings. Salary packaging is the ATO’s way of letting you squeeze your pennies for everything they’re worth before giving them to the taxman. It can reduce your taxable income and increase your net income. This tax-approved strategy allows contractors in Australia to maximise their take-home pay by restructuring their income to receive certain benefits before tax.
Understanding the small print and technicalities of salary packaging, from eligible items to tax implications, will help you make a well-informed financial decision. This guide unwraps how maximising your take-home pay with salary packaging as a contractor works, the items you can include, the differences between salary packaging and salary sacrifice, and other aspects contractors should consider to fully benefit from this arrangement.
What is Salary Packaging?
Salary packaging is an arrangement where an employee agrees to forgo a portion of their future salary in exchange for benefits of similar value provided by their employer. The ATO approves this method and allows employees, including contractors, to receive certain benefits before tax. These benefits can include vehicles, laptops, and additional superannuation contributions, all of which reduce taxable income and, therefore, the amount of tax payable.
The critical advantage of salary packaging is the potential reduction in taxable income, leading to significant tax savings. For example, if you earn $100,000 annually and salary packaging $10,000 worth of benefits, you will only be taxed on $90,000, effectively reducing your tax liability.
How Does Salary Packaging Work?
The first step in initiating salary packaging is to discuss your options with your employer or payroll management service. This ensures that the benefits you wish to package are approved by the ATO and align with your employment contract.
Here’s a step-by-step guide on how to go about salary packaging an item:
- Identify Eligible Items: Determine which items you wish to include in your salary package. Common options include vehicles through novated leases, laptops, mobile phones, and additional superannuation contributions
- Formal Agreement: Once the items have been identified, you must enter into a formal agreement with your employer which outlines the specifics of the salary packaging arrangement, including the items being packaged and the amount to be deducted from your salary
- Application Process: Complete any necessary application forms provided by your employer or payroll service. This might include providing details of the items you want to package and their costs
- Approval and Setup: Your employer will review the application and, if approved, set up the salary packaging arrangement. This typically involves adjusting your payroll system to deduct the agreed amounts from your pre-tax salary each pay cycle
- Ongoing Management: After the setup, your employer will deduct the cost of the packaged items from your gross salary before tax is calculated. This reduction in taxable income can lead to significant tax savings and an increase in your net pay
- Review and Adjustments: Periodically review your salary packaging arrangement to ensure it continues to meet your needs and complies with any changes in tax regulations. You can adjust the items included in your package or the amounts deducted as needed
Having a formal agreement with your employer is crucial to setting up and managing the salary packaging items. Employers typically offer a range of benefits that can be packaged, and the specifics can vary based on the nature of the work and the employer. By following these steps, contractors can effectively manage their salary packaging arrangements, ensuring they maximise their tax savings and increase their disposable income.
Salary Packaging Benefits for Contractors
Contractors can benefit from salary packaging a variety of items approved by the ATO, including:
- Vehicles via Novated Leases: A novated lease involves a three-way agreement between the contractor, the employer, and a finance company. This arrangement allows you to lease a vehicle using pre-tax income, offering potential savings on GST and running costs
- Laptops and Mobile Phones: These commonly used items can be included in salary packaging, especially if they are predominantly for work-related use
- Superannuation Contributions: Salary packaging can include additional contributions to superannuation, enhancing retirement savings while lowering taxable income
- Work-related Expenses: This can encompass salary packaging meal allowances for contractors and other business-related expenses, such as tools of the trade
Contractors can significantly reduce their taxable income and increase their net earnings by packaging these items.
Who Can Salary Package?
While salary packaging is commonly associated with permanent employees, contractors can also benefit from these arrangements. Contractors must have a formal agreement with their employer or a payroll management service to facilitate salary packaging. Salary packaging is particularly beneficial for independent contractors who don’t have access to traditional employee benefits but can still take advantage of the tax savings offered by salary packaging.
Employers and payroll management services typically provide the necessary support and infrastructure to manage salary packaging for contractors, ensuring compliance with ATO regulations.
Salary Packaging a Car for Contractors (Novated Leasing)
Novated leasing is a popular salary packaging option where a vehicle lease is transferred to an employer, allowing the contractor to make lease payments from their pre-tax income. This arrangement offers significant tax advantages and can reduce the cost of maintaining a vehicle.
In a novated lease, the employer takes on the lease obligations deducted from the contractor’s pre-tax salary. A novated lease reduces the contractor’s taxable income and provides potential savings on GST and running costs. Novated leases are particularly beneficial for contractors who require a vehicle for work and want to maximise their tax savings.
Source: ASPIA
Novated vs. Associate Car Lease
In a novated lease, the employer takes on the lease obligations, and the contractor pays for the lease using pre-tax dollars. In contrast, an associate lease involves the contractor leasing the car to their business and claiming deductions on the lease payments. While both options have benefits, novated leasing generally provides more tax advantages and simplicity for contractors.
Novated leases are typically easier to manage and offer clearer tax benefits than associate leases, making them a preferred option for many contractors.
Where Does the Fringe Benefits Tax Fit?
Fringe Benefits Tax (FBT) is a tax employers pay on certain benefits provided to employees, including contractors. When salary packaging items attract FBT, it can impact the overall benefit. Employers usually factor FBT into the salary packaging arrangement to ensure it benefits the contractor.
For example, if a packaged item like a car or a laptop is considered a fringe benefit, the employer is then liable for the FBT. However, the tax savings from the reduced taxable income often outweigh the cost of the FBT, making salary packaging advantageous overall.
Salary Sacrifice vs. Salary Packaging
While often used interchangeably, salary sacrifice and salary packaging have slight differences. Salary sacrifice typically refers to superannuation contributions, while salary packaging can incorporate a broader range of items. Both arrangements aim to reduce taxable income, but salary packaging offers more flexibility in the benefits you can receive.
Conclusion
While salary packaging seems like it should be gift-wrapped and handed out to everyone, it pays to do your sums and find out how it can work for you as a contractor first. When it works, it can be a valuable tool to maximise the income of contractors and reduce tax liabilities. By understanding the nuances of the tax benefits of salary packaging for contractors in Australia, including eligible items, novated leases, and FBT implications, you can make informed decisions about increasing your disposable income. An effective salary packaging strategy is a great way to reduce your taxes and increase your earnings.
SDP Solutions can help you manage salary packaging
Managing payroll for independent contractors can be complex, but SDP Solutions can handle it. We ensure compliance and streamline payment processes, allowing your business to focus on more commercial initiatives.
Please contact us for more information on how we can support you.
