Is It Time to Restructure Your Business? Unlock Tax Savings and Protect Your Assets

Discover how shifting from a sole trader to a company or trust can help you save on taxes, protect your assets, and set your business up for long-term success.

When it comes to changing your business structure from a sole trader to a company or trust, there are generally three main reasons to consider: 

1. Asset Protection 

As a sole trader, your personal assets are not legally separated from your business assets. This means that if your business faces legal action or financial issues, your personal assets (e.g., house, savings) could be at risk. By incorporating as a company or setting up a trust, you create a legal separation between your business and personal assets, providing an additional layer of protection. 

2. Risk Mitigation / Legal Protection 

Closely tied to asset protection, operating as a company or trust can limit your personal liability. For example, in a company, shareholders are generally not personally liable for the company’s debts beyond their investment. Similarly, trusts can protect assets from business risks by separating ownership from control, helping shield personal assets from any business-related legal action. 

3. Tax Planning 

Both companies and trusts offer more flexibility in tax planning. Sole traders are taxed at their personal income tax rate, which can be higher than the corporate tax rate. A company is typically taxed at a lower rate, while a discretionary trust allows for income splitting among beneficiaries, potentially reducing the overall tax burden. 

Starting as a Sole Trader: Why it’s a Popular Choice 

Most people begin their businesses as sole traders because it’s the simplest and most cost-effective structure to set up and maintain. In a previous BLOG, I discussed the pros and cons of being a sole trader. Often, entrepreneurs start as sole traders to test the waters and reassess their business structure once they see steady profits. 

However, some businesses—especially those with higher risk—might choose a more complex structure, such as a company, right from the start. For example, a retail business or restaurant carries higher risks, as customers regularly enter the premises, increasing the potential for accidents. There is also greater risk for employees compared to a sole trader who works from home. 

In such scenarios, a company structure helps limit personal liability—any legal action would generally be directed at the company, not the director or shareholders. 

Tax Planning: How a Company Structure Can Save You Money 

Tax planning is one of the most significant factors when deciding whether to restructure your business. For instance, let’s assume a sole trader has a taxable income of $180,000 for the 2024/2025 financial year. This sole trader would pay $47,900 in income tax, plus $3,600 in Medicare levy, regardless of whether they distribute all their profits to themselves or retain a portion within the business. 

Let’s now consider the same business owner restructuring into a company. Suppose they pay themselves a salary of $150,000, plus $17,250 in superannuation contributions (11.5% of $150,000). The remaining net profit of the business would be $12,750. 

Breakdown of Tax 

• Company tax: $3,187 (25% of $12,750) 

• Business owner tax: $36,838 (on $150,000 salary) 

• Medicare levy: $3,000 

The total tax burden for the business structure would be $43,025, resulting in a tax saving of $8,475 compared to the sole trader scenario. 

A company structure is particularly advantageous if the business owner is comfortable retaining profits within the company. These retained profits can later be distributed as dividends, which may also be eligible for franking credits—offering additional tax benefits. 

Family Trusts: Clarifying Common Misconceptions 

There is a lot of misinformation about tax and family trusts. Over the years, I’ve heard claims like, “Set up a family trust and you won’t have to pay tax.” This is a common misconception. I’ve also heard stories about business owners who have spent decades distributing profits to family members to reduce their tax liabilities, only to find that these strategies now complicate their retirement and impact their adult children. 

Understanding Trusts and Tax Responsibilities 

One of the key things you need to know about family trusts is that the trust itself doesn’t pay tax—the beneficiaries do. The trust's profits must be distributed to a beneficiary (either an individual or a company), and it is the beneficiary who is responsible for paying tax on that income, not the trust itself. If profits are not distributed, the trust will be taxed at the top marginal tax rate (currently 45%). 

For minor beneficiaries (under 18 years old), there are strict tax rules. They can only receive $416 in trust distributions tax-free. Amounts between $417 and $1,307 are taxed at 66%, and amounts over $1,307 are taxed at the highest rate of 45%. This means the days of spreading profits across numerous children, nieces, and nephews to reduce taxes are long gone. 

It’s crucial to understand these rules to avoid unexpected tax consequences, especially as your business approaches retirement. 

When Trusts Work Best: The Benefits of Multiple Adult Beneficiaries 

Trusts work most effectively when there is more than one adult beneficiary to distribute income to. For example, consider a sole trader making $180,000. If they set up a trust but are the only beneficiary, they would still pay $47,900 in income tax, plus $3,600 in Medicare levy—the same as if they remained a sole trader. So, why set up a trust in this scenario? The main reasons could be risk mitigation and future tax planning—such as distributing profits to children once they become adults and beneficiaries. 

Example of Income Splitting with a Trust 

Let’s say the same sole trader earns $180,000, but this time they have a spouse who works part-time and earns $20,000. Under the trust structure, the profits can be split so that both adult beneficiaries have taxable incomes of $100,000 each. 

• Total taxable income: $200,000 ($180,000 + $20,000) 

• The primary beneficiary’s tax liability would be reduced to $20,788, with a Medicare levy of $2,000. 

• Total combined tax liability: $45,576, compared to $51,500 if the income were not split. 

By distributing the income, both beneficiaries fall into a lower tax bracket, resulting in significant tax savings. 

Weighing the Pros and Cons of a Company vs. Trust 

When considering a trust or company for your business structure, you need to carefully weigh the potential downsides of each option. Companies are governed by the Australian Securities and Investments Commission (ASIC) and come with strict regulations. One critical rule to remember is that the company's money does not belong to you. 

If you’ve been disciplined as a sole trader—keeping a separate bank account and paying yourself a regular "wage"—you’ll find the transition to a company structure relatively straightforward. However, things become more complicated when you take money from the company for personal use. 

This can trigger Division 7A, which requires any money taken from the company to be treated as a loan, with proper loan terms and interest rates. If no formal loan agreement is in place, the money taken will be treated as an unfranked dividend, meaning the recipient will pay tax on the amount through their personal tax return without franking credits. 

Trusts vs. Companies: Key Differences 

Unlike companies, trusts are not separate legal entities. A trust is an arrangement where a trustee holds and manages assets on behalf of beneficiaries, as outlined in the trust deed. While most trusts follow a similar framework, variations may exist depending on the specific needs and intentions when the trust is created. 

If the trustee is also the primary beneficiary and uses trust funds for private expenses, this would typically be considered part of their distribution. The trustee would then pay tax on that distribution as part of their income. 

No rules are broken as long as the trustee follows the terms set out in the trust deed. However, it’s important to document and account for these distributions properly to avoid tax issues. 

Conclusion: Choose the Right Structure for Your Business 

Both company and trust structures offer unique benefits, but they also come with their own rules and responsibilities. As a business owner, it’s important to evaluate your own ability to comply with these rules to reap the benefits of these structures. Whether it’s protecting assets, reducing taxes, or mitigating risk, understanding the ins and outs of each structure will ensure that your business is set up for success in the long term. 

Disclaimer: The information provided in this blog is for general informational purposes only and should not be considered as financial, legal, or professional advice. Always seek the assistance of a qualified professional before making any decisions regarding your business structure or financial planning