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NEWS - PLANNING
Redundancy package caution
10/29/2001
A recent survey of blue chip Australian businesses by the outplacement firm Lee Hecht Harrison found that 87 per cent of businesses that have recently downsized are planning further job cuts in the next 12 months.
If you're in the firing line, and contemplating whether to hang around or to take the money and run, it's important not to take the company's word for the best way to take your payout.
For example, in one recent case, a company offered nine months' pay in return for separation from an executive's job. The company said the tax on the termination payout would be capped at 31.5 per cent. But the person's accountant, after taking a closer look, discovered that the real tax rate on the so-called "golden handshake" came out closer to 70 per cent.
In doing the sums, the company had ignored the superannuation surcharge - a big trap on termination payouts - and reasonable benefits limits (RBLs), which restrict the amount of concessionally-taxed superannuation.
The person was shocked at the tax bill. And this incident is not infrequent.
Rowan Wall, the principal of Eclipse Financial Group in North Sydney, says that the firm has been inundated with requests to advise employees who have been made offers that they aren't supposed to refuse. In nearly all cases, he says, employers are misleading people on how much they will receive after tax from a termination benefit.
"We had to highlight to an employer last week that by paying what they called a 'concessionally-taxed benefit', the employee was actually facing an effective tax rate of 73.7 per cent," says Wall.
Another executive faced an effective tax rate of 65.62 per cent once the superannuation surcharge and reasonable benefit limits were factored in. Neither issue was factored in by the employer. "This is not a one-off situation," Wall says. "There is hardly an exception to the situation where employers are not notifying employees about the effect of their termination payment on the surcharge and superannuation benefits."
The tax situation on redundancy has always been complicated but with many people going through the process for the second or third time, knowing the tax bill before you agree to the company offer is even more critical.
In the executive's case, the company calculated tax on the payout at 31.5 per cent (see box for explanation). "But to this must be added the superannuation surcharge, which takes the effective tax rate to 46.5 per cent.," says Wall.
The surcharge is based on adjusted taxable income and cuts in at $85,242, where it's 1 per cent of super contributions, rising to 15 per cent of contributions at $103,570.
Wall cautions that it's not just people on big incomes who are being hit by the superannuation surcharge, as it applies to all superannuation contributions once an employee reaches the $85,242 trigger, not just amounts in excess of that.
Long service leave, annual leave and severance payments (excluding the tax-free amount) are included in the calculation of adjusted taxable income.
"So someone on a salary of $50,000 and $20,000 superannuation a year who receives a redundancy payout of $30,000 plus another $10,000 in accrued leave is well into surcharge territory," Wall says.
In addition to the surcharge, 85 per cent of the eligible termination payout (ETP) is counted against reasonable benefit limits.
Benefits over the lump sum RBL - $506,092 this year - are taxed at the top marginal rate of 48.5 per cent, whereas normal superannuation entitlements are taxed at a maximum of 16.5 per cent. So breaching your RBL is equivalent to adding 27.2 per cent to the effective tax on a payout, bringing the total rate to more than 73 per cent.
Wall says young people can get into RBL problems without even knowing it as the limit is discounted by 2.5 per cent for every year you are below 55 years of age.
For somebody aged 45, the RBL is discounted by 25 per cent. For 35-year-olds, the RBL is almost reduced by half.
"Young executives can really get caught out as it only takes a few golden handshakes for reasonable benefit limits to start cutting in. And with the technology boom, a lot of younger people were in a lot of higher positions then they were before."
Wall says employees may be at or close to the RBL should carefully consider the structure of their payout.
In the executive's case, for instance, he negotiated to work out the notice period, which meant six months of the payout could be paid as salary instead of an ETP and taxed at 48.5 per cent (instead of 70 per cent) without creating RBL or surcharge issues.
Wall also suggests structuring the payout as fringe benefits by having the employer pay out the personal credit card or home loan before termination to cap tax at the top marginal rate.
Wall says he can't see why the Tax Office would have a problem with employees who want to limit themselves to paying the top rate of tax. "Why can't somebody be given the right to be taxed at the highest marginal rate of tax and have no other implications?"
In many cases, the big problem is convincing an employer to come to the party, and employees should be willing to use any leverage they have, Wall says. "If you're an employer and you've got a guy who's worked for you for 20 years and you turn around and say 'We're going to pay you out but all of your superannuation is now going to be taxed at 48.5 per cent' - well, that's not a very nice goodbye position. Take the high moral ground. They're probably in the firing line too."
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