How a Sole Trader Business Works
The sole trader business structure is one of the simplest and cost effective business structure in Australia. As a sole trader, you as an individual will own, control and manage the business in your own personal name. This means there is no legal separation between you and the business. Business profits are 100% yours to be taxed on and can’t be split with a family member or business partner.
Your business will be taxed using your personal Tax File Number (TFN) at individual tax rates. But you will need to apply for an ABN (Australian Business Number), this is what links you to your business. If you aren’t going to use your name for the business, you also need to register a business name with ASIC. For example you can be “Sally Jones Cleaning “ and not register a business name but if your business name is “The Cleaning Fairy” then you need to register this name.
Pros of being a sole trader
Very few startup costs: Registering a business name with ASIC will cost $42 per year or $98 for 3 years. Any other costs beyond this are unique to you and the type of business you choose to operate.
Easy to file a tax return: A sole trader business is linked to the owners TFN so the business return is completed as part of the individuals tax return. This means there is only one return you need to lodge each year, and this is your Individual Tax Return (ITR). In your ITR there is an additional section to complete if you are a sole trader.
You have full control of the business: You are the person with ultimate control of the business. You can make all the decisions without the approval of other Directors or shareholders.
Fewer Reporting requirements: Generally, the only info you’ll be reporting to the Government is in your ITR and BAS (if you are GST registered). You will need to keep financial records for 5 years.
Disadvantages of being a sole trader
Unlimited Liability: Because there is no differentiation between you and your business, you can then be held legally responsible for liability. An example of this would be if you were working in a client's home and caused damage the client could sue you and your personal assets (e.g. home, personal bank account) could be used to cover any compensation. This is why it is very important for a sole trader to always have public liability and professional indemnity insurance to protect personal assets.
Limited options for tax planning: As a sole trader you will be taxed on all your business profit, regardless of if you “paid” the profit to yourself or left it in the business bank account. Your sole trader profit gets added to any other income you might have; this forms your taxable income and what you pay tax on.
Lack of Continuity: If the sole trader dies or retires the business will cease to exist. Sole Traders can sell their business though.
Limited Capital Sources: Sourcing capital (funding) can be difficult because the financier will look at the individual and if you can personally service the loan.
Some customers won't deal with sole traders: There is a perceived risk with dealing with sole traders due to unlimited liability. It’s important to know who your ideal customer is before starting your business. In the example of Sally, the cleaner, if she is choosing to do house cleans there shouldn’t be an issue attracting homeowners as a client. If her ultimate goal is to be cleaning for commercial clients, the sole trader structure may inhibit this.
Things a Sole Trader business can do:
Keep all the businesses profit/ income
Register its own business name
Hire people. If you have employees there are legal obligations to withhold tax and pay super.
Pay superannuation into the owner's super fund (if you want to). Super is optional for the business owner.
Have a separate business bank account.
Take money out of the business account and transfer it into the business owner's account (drawings).
Be GST registered.
Upgrade your business structure (e.g. if you decide you want to change your business to a company you can)
You can sell the business.
Things a sole trader can’t do:
Pay themselves a “wage”. Any money given to the owner isn't tax deductible.
Transfer business profits to a family member or partner to limit tax.
Take on business partners or have co-founders.
Case Study
Sally has a cleaning business. Her net profit was $91,400 after all eligible business deductions were claimed. She paid herself $50,000 and any other profit remained in the business bank account.
$91,400 business profit will be included in Sally’s return and reported as assessable income, not the $50,000 she paid herself.
Sally also had a part time job during the year. She was paid $35,000 and had $4,000 tax withheld from her wages (PAYGW).
In her Tax Return the $91,400 of business income will be added to the $35,000 of employment income leaving Sally with a total taxable income of $126,400.
The tax and Medicare levy on this is $34,363
Sally's employer withheld enough tax to cover her employment income but not enough to also cover her business. This means Sally will owe the ATO $30,363, ($34,363 tax less $4,000 PAYGW)
Note Sally still has $41,400 in her business account as savings. She can use this money to pay her personal tax debt.
This blog provides information that is general in nature. For advice unique to you and your business please reach out to a tax professional. We offer advice for sole traders in the start up phase with our Small Biz Brainstorm Session.
