Working on your own (sole trader) or running a company are two ways to go about conducting business.
You’ve completed your learnings, put in your hours working for someone else, and now it’s the moment to start your own business.
Starting your own thing, even if it means working with the same company as a subcontractor, is a really exciting step for any tradesperson.
However, there are a few important things you need to do before you can get started, and one of those is deciding how your business will be set up.
There are several options, but for most tradespeople, the main choice comes down to either being a sole trader or forming a company. In Australia, these two ways are popular and regularised by proper authorities.
In this article, we’ll explore both options so that you can decide as to which path to follow.
Overview Of The Differences Between A Sole Trader and A Company
Now, with a company, it’s like a separate entity with its own TFN and ABN.
So, what does this mean practically?
Well, as a sole trader, you, as the owner, and your business are like a package deal. So if your business runs into financial trouble or gets into legal trouble, you’re personally on the hook for it.
But with a company, it’s like having a legal wall between your personal stuff and your business stuff. If your company faces financial issues or legal problems, it’s usually only the company’s money and assets that can be affected, not your personal stuff.
Of course, there are some exceptions where your personal stuff can still be at risk, but for most tradespeople, that only happens if you’ve done something illegal.
What Is A Sole Trader?
This is the most basic way to run a business.
A sole trader is someone who runs the whole show by themselves. Even if you hire others to help, you’re the one in charge, and you’re legally responsible for everything the business does. In the eyes of the law, your business and you are like a package deal – you both use the same tax and business numbers.
Plus, any money the business makes or debts it racks up are all on your shoulders; you can’t split that responsibility with anyone else except yourself.
How Does The Sole Trader Tax Work In Australia?
If you’re running your own business as a sole trader in 2024, the amount of tax you owe will be based on how much money you make. This means the profit you earn from your business after subtracting allowable deductions.
As a sole trader, you’re required to pay taxes at your individual tax rates. These rates can vary, but for the 2023-24 financial year, they look like this:
1. If your income is up to $18,200, you won’t have to pay any tax (this is known as the tax-free threshold).
2. If your income falls between $18,201 and $45,000, you’ll pay 19 cents for every extra dollar over $18,200.
3. If you earn between $45,001 and $120,000, you’ll pay $5,092 plus 32.5 cents for each extra dollar over $45,000.
4. For incomes ranging from $120,001 to $180,000, you’ll owe $29,467 plus 37 cents for every additional dollar over $120,000.
5. If your income exceeds $180,000, you’ll pay $51,667 plus 45 cents for every extra dollar over $180,000.
Keep in mind that tax laws and rates can change over time, so it’s crucial to stay updated with any revisions.
Additionally, as a sole trader, you might have other taxes to consider. For instance, if your business’s annual turnover reaches $75,000 or more, you’ll need to pay a 10% goods and services tax (GST). There’s also the Medicare Levy, which amounts to 2% of your taxable income.
What Is A Company?
A company is like its own separate entity with legal rights that are separate from the people who own it. These owners are called members or shareholders.
Basically, every company needs to have at least one of these members. Because of its legal status, a company is treated almost like a regular person in the eyes of the law. This means it can borrow money, take legal action, or be taken to court, just like a real person can.
What Are Taxes On Companies In Australia?
This is a vast topic and you can refer to our tax systems in Australia guide to know how the tax regimes work in the country.
There are three taxes that companies in Australia have to pay: Company or Income Tax, Capital Gains Tax (CGT), and Goods and Services Tax (GST). Other than that, there are some minor taxes as well like fringe benefits tax and payroll taxes.
All the taxes that we’ve mentioned above are dynamic and the tax rate depends on the company size and turnover. It is only GST that is fixed at 10% and has always been since its inception in the year 2000.
Pros & Cons of Being a Sole Trader
Pros of Being a Sole Trader in Australia:
- Simplicity and Control:
– Pros: As a sole trader, you have complete control over your business decisions and operations. You can make quick decisions without needing approval from partners or shareholders.
– Cons: The simplicity can also be a drawback if you need additional expertise or financial resources that may not be readily available as a sole trader.
- Tax Benefits:
– Pros: Sole traders benefit from straightforward tax reporting. Business income is typically treated as your personal income, and you can claim deductions for business-related expenses. You may also be eligible for the Small Business Tax Offset.
– Cons: On the downside, you are personally liable for all the business’s debts, and your personal assets may be at risk in case of bankruptcy.
– Pros: Sole traders enjoy flexibility in terms of work hours and business decisions. You can adapt your business quickly to changing market conditions without the need for extensive paperwork or approvals.
– Cons: The flip side is that you may need to work long hours or handle all aspects of the business, including administrative tasks, which can be overwhelming.
- Lower Start-up Costs:
– Pros: Setting up as a sole trader generally involves lower initial costs compared to other business structures. There’s less administrative red tape, making it easier and cheaper to get started.
– Cons: However, you might face limited access to capital, making it challenging to expand or invest in the business’s growth.
Cons of Being a Sole Trader in Australia:
- Unlimited Personal Liability:
– Pros: You have complete control over your business decisions and operations.
– Cons: The downside is that you are personally liable for all business debts. This means your personal assets, such as your home and savings, may be at risk if the business runs into financial trouble or faces legal issues.
- Limited Access to Capital:
– Pros: Lower start-up costs make it easier to get your business off the ground.
– Cons: Sole traders often have limited access to capital. Raising funds for expansion or investments can be challenging, as you can’t sell shares in your company.
- Limited Tax Benefits for High Earners:
– Pros: Simplified tax reporting can be an advantage.
– Cons: High-earning sole traders may face a higher personal income tax rate compared to corporate structures. The flat personal income tax rate does not provide the same tax advantages as a corporate tax rate.
- Limited Continuity and Growth Potential:
– Pros: Sole traders enjoy flexibility in business decisions.
– Cons: The business’s continuity is tied closely to the sole trader, making it challenging to pass on or sell the business. This structure can limit long-term growth and succession planning.
Pros of Running a Company in Australia:
- Limited Liability:
– Pros: One of the primary advantages of forming a company is limited liability. Shareholders’ personal assets are generally protected from the company’s debts and legal liabilities.
– Cons: While personal assets are usually protected, directors can be held personally liable in certain circumstances, such as in cases of insolvent trading or fraud.
- Access to Capital:
– Pros: Companies have greater access to capital compared to sole traders. They can issue shares to raise funds, attract investors, and potentially access loans and grants.
– Cons: The process of raising capital through share issuance can be complex and may dilute the ownership and control of existing shareholders.
- Tax Benefits:
– Pros: Companies in Australia often benefit from lower tax rates on business income compared to individual tax rates. The current corporate tax rate for small businesses is lower than the top personal income tax rate.
– Cons: While corporate tax rates can be advantageous, companies must also navigate more complex tax reporting and compliance requirements.
- Continuity and Succession Planning:
– Pros: Companies can have perpetual existence, making them suitable for long-term business planning, succession, and transfer of ownership.
– Cons: However, this can also mean a lack of flexibility in winding up or restructuring the company if needed.
Cons of Running a Company in Australia:
- Complex Compliance and Reporting:
– Pros: Companies enjoy limited liability for shareholders.
– Cons: The trade-off is increased administrative complexity. Companies are subject to more rigorous reporting and compliance requirements, including annual financial statements and ASIC (Australian Securities and Investments Commission) filings.
- Higher Start-up Costs:
– Pros: Companies have access to a wider range of capital-raising options.
– Cons: Setting up and maintaining a company can be more expensive than other business structures, due to registration fees, ongoing compliance costs, and the need for professional advice.
- Loss of Privacy:
– Pros: Companies have greater potential for attracting investors and growing the business.
– Cons: Information about the company, including financial statements and director details, is publicly available, reducing privacy compared to sole traders.
- Complex Decision-Making:
– Pros: Companies have more resources and access to capital.
– Cons: Decision-making can be more complex, involving multiple stakeholders such as directors, shareholders, and potentially investors. This can lead to conflicts and slower decision-making processes.
The choice between operating as a sole trader or forming a company in Australia depends on factors like your business goals, risk tolerance, access to capital, and willingness to comply with regulatory requirements. Seeking advice from legal and financial professionals is advisable when making this decision.
In conclusion, the decision between operating as a sole trader or forming a company in Australia boils down to a multitude of factors that align with your unique business aspirations and circumstances. Both paths have their merits and demerits, offering distinct advantages and challenges.
Sole traders relish the simplicity and control they wield over their enterprises, along with streamlined tax reporting. However, the trade-off comes in the form of unlimited personal liability and potentially limited access to capital for expansion.
On the flip side, companies revel in limited liability, making it a safer bet for protecting personal assets. They also enjoy greater access to capital, potentially lower tax rates, and long-term continuity planning. Yet, these benefits come hand in hand with increased administrative complexity, higher start-up costs, and a loss of privacy.
As you ponder your business’s future, consider your goals, risk tolerance, and financial needs. The landscape is dynamic, with tax laws and regulations evolving. So, staying informed and seeking professional advice is crucial.