Linda Bruce, senior technical services manager at CFS, said while Division 293 tax is generally thought of as tax-payable by high-income earners based on concessional contributions, that is not always the case.

She gave an example based on an adviser’s query of Gabby, 45, who had taken time off from work to raise a family and then returned on a part-time basis.

Her annual salary was $45,000 and the super guarantee was paid on top of that.

“Gabby’s top priority was to build her retirement savings and based on that an adviser recommended her to salary sacrifice $20,000 to super on a yearly basis, so that her taxable income after the salary sacrificing is reduced to $25,000. This means Gabby is only liable to pay very minimal income tax plus Medicare levy," Ms Bruce said.

“The adviser also recommended the government co-contribution strategy”.

Unfortunately, Gabby’s father passed away and, following the death benefit nomination, the trustee of the super fund paid the super death benefit payment directly to Gabby in July 2023.

“The taxable taxed element of this super death benefit was $300,000. Gabby’s father passed away over age 65 so there’s no taxable untaxed element in this case,” she said.

“As the death benefit was paid by the fund directly to Gabby, the taxable taxed element of the super death benefit now forms part of Gabby’s assessable income and Gabby is the taxpayer who needs to pay the super death benefit tax.”

Ms Bruce said the adviser was aware that the taxable tax element of the super death benefit payment is taxed at Gabby’s marginal tax rate but capped at 15 per cent plus the Medicare levy.

“The question the adviser had was how the $300,000 taxable element from the super death benefit interacts with the remaining $25,000 taxable salary that Gabby is receiving,” she said.

“The adviser was essentially asking which income is considered to be the first slice of income – is it the $25,000 and then the $300,000 sits on top of that? Or is it the other way around?”

Ms Bruce said there is a specific order to tax income that is subject to different tax rates.

“My understanding of the tax practice is that ordinary income subject to the normal marginal tax rates is taxed first,” she said.

“Now, we might have a different lump sum income subject to different maximum tax rates. These types of lump sum income will be added on top of the ordinary income and will be taxed at the marginal tax rate but capped at the applicable maximum tax rate.

“In this particular case, the $25,000 taxable salary will be subject to the normal marginal tax rate and will be taxed first. This means that the $18,200 tax-free threshold can be applied to this income.

“The remaining salary is taxed at 19 per cent and because the marginal tax rate at this point is already higher than 15 per cent, the tax element of the super death benefit payment is then added to the $25,000 ordinary income and taxed at a flat rate of 15 per cent.”

Additionally, in this scenario, Ms Bruce said Gabby would no longer be able to receive the government contribution for this particular financial year due to the increase in Gabby’s assessable income.

“It’s also no longer tax effective for Gabby to salary sacrifice to super in this financial year. This is because the $20,000 salary sacrifice amount is taxed at 15 per cent within the super fund, however, Gabby will receive a Division 293 tax notice from the ATO after the end of the current financial year which means the total tax payable on the $20,000 the salary sacrifice would be taxed at 30 per cent. If Gabby stopped salary sacrificing to super for this year, the $20,000 would be taxed at 21 per cent including Medicare levy.”

Not just for high-income earners

This case study highlights that Division 293 tax is not just applicable to high-income earners, she said, and it’s important to understand how it works.

“At a high level, Division 293 income can include the client’s adjustable taxable income for Medicare levy surcharge of purposes, plus the concessional contributions that the client made during the financial year that were within the concessional contributions cap,” she said.

“You really need to look at a client’s taxable income, which is calculated as the assessable income minus the tax deductions, and then add back things such as reportable fringe benefits and investment losses.

“The taxable income not only can include the regular ordinary income, but also can include any taxable lump sums, such as net capital gains, employment or termination payments, and the taxable component of a super death benefit payment”.