What Can You Salary Sacrifice? Common Items Explained

Salary sacrifice is an arrangement where an employee agrees to reduce their future gross salary in exchange for non-cash benefits of a similar value. This agreement is made directly with the employer before any work is performed or salary is earned. It effectively means a portion of the employee’s compensation is redirected to cover the cost of certain benefits, rather than being received as taxable wages. This formal agreement allows specific benefits to be funded from pre-tax income, potentially altering an individual’s taxable earnings.

Common Categories of Salary Sacrifice Items

Many types of non-cash benefits can be part of a salary sacrifice arrangement, though their availability depends on the employer’s offerings. These arrangements frequently involve contributions to retirement accounts, which are a widely utilized option. Employees can make additional contributions to qualified retirement plans, such as 401(k)s, directly from their pre-tax salary. For 2024, the Internal Revenue Service (IRS) permits employees to contribute up to $23,000 to their 401(k)s, with an additional catch-up contribution of $7,500 allowed for those aged 50 and over. This reduces the employee’s taxable income for federal income tax purposes and often for state income taxes as well.

Work-related items frequently fall under salary sacrifice agreements, provided they are genuinely connected to employment duties. This can include items such as laptops, mobile phones, or home office equipment. Professional development courses, subscriptions, or memberships that enhance job skills or are required for employment can also be included. These items are generally treated as working condition fringe benefits, meaning their value can be excluded from an employee’s gross income if they would have been deductible as an ordinary and necessary business expense had the employee paid for them directly.

Childcare costs represent another common category for salary sacrifice through employer-sponsored Dependent Care Assistance Programs (DCAP). Employees can set aside pre-tax dollars to pay for eligible childcare expenses for dependents under age 13 or for disabled adult dependents. For 2024, the maximum amount an employee can contribute to a DCAP is $5,000 for single filers or married couples filing jointly, and $2,500 for married individuals filing separately. This pre-tax contribution reduces the employee’s taxable income, lowering their federal income tax burden.

Health insurance premiums are a widely adopted salary sacrifice item, typically managed through a Section 125 Cafeteria Plan. Under such plans, employees can elect to have a portion of their salary deducted before taxes to cover the cost of health, dental, and vision insurance premiums. These pre-tax deductions reduce an employee’s taxable income for federal income tax, Social Security, and Medicare taxes. Section 125 plans can also include other qualified benefits like flexible spending accounts (FSAs) for healthcare or dependent care expenses.

Establishing a Salary Sacrifice Arrangement

Establishing a salary sacrifice arrangement requires a formal, written agreement between the employee and employer. This agreement must be in place before the employee performs the work. This pre-arrangement legally reduces the employee’s gross salary, ensuring the sacrificed amount is never received as cash wages. This fundamentally changes the basis for income and payroll tax calculations.

The agreement should clearly specify the portion of salary being sacrificed and the non-cash benefit being received in exchange. For benefits like health insurance premiums or dependent care, this often involves enrollment in a Section 125 Cafeteria Plan, which is a formal plan document maintained by the employer. For retirement contributions, the arrangement is typically part of the employer’s qualified retirement plan, such as a 401(k). These plans adhere to strict IRS regulations to maintain their tax-advantaged status.

Once the agreement is formalized, the employer processes the payroll by deducting the sacrificed amount from the employee’s gross pay. This deduction occurs before federal income tax, Social Security (FICA), and Medicare taxes are calculated and withheld. As a result, the employee’s taxable income, and consequently their tax liability, is reduced. The employer also benefits from lower payroll taxes (FICA and FUTA) on the sacrificed amount, as these taxes are based on the reduced gross salary. This mutual benefit motivates both parties to participate in such arrangements.

Factors Affecting Salary Sacrifice Eligibility

An employee’s ability to engage in salary sacrifice arrangements depends entirely on the employer’s discretion. Employers are not mandated to offer these schemes; they implement them as part of their employee benefits package. Therefore, the scope and types of benefits available are determined by the employer’s specific policies and plans.

Minimum wage requirements can limit the amount of salary that can be sacrificed. The Fair Labor Standards Act (FLSA) sets federal minimum wage standards, and any salary sacrifice arrangement cannot reduce an employee’s effective pay below this federal minimum, or any higher state or local minimum wage that applies. This ensures that employees always receive at least the legally required minimum compensation for their work. Compliance with these wage laws is a primary consideration for employers when structuring salary sacrifice programs.

Reducing one’s gross salary through sacrifice can also impact other entitlements calculated based on gross pay. For instance, future Social Security benefits are determined by an individual’s earnings history, and a lower reported gross salary over time could result in a slightly lower Social Security benefit upon retirement. Similarly, employer matching contributions to retirement plans, disability insurance benefits, or even unemployment compensation may be affected if they are based on gross wages rather than the effectively reduced taxable income.

Employers also consider fringe benefits tax implications when offering salary sacrifice options. Most fringe benefits are generally taxable to the employee unless specifically excluded by law. Employers also have responsibilities regarding reporting and, in some cases, paying taxes on the value of these benefits. These tax considerations influence which benefits employers are willing and able to offer through salary sacrifice arrangements.