What is the definition of sole trader?
It simply is a business structure where one person owns and manages this business. This person is responsible for all aspects of the business, including debt and losses. The sole trader can employ others in the business, but not themself. When taking money out of the business, it’s not accounted for as an expense but as “owner drawings”. A sole trader by definition is legally responsible for paying employee superannuation and can voluntarily pay into their personal super account for retirement.
What are some sole trader advantages?
The biggest advantages of this business structure are the low cost and simplicity of setting up, as well as fewer reporting requirements. While setting up a company (usually a proprietary company limited by shares, abbreviated as Pty Ltd) isn’t expensive (from $400 to $600) there is more paperwork involved and annual fees and reporting requirements. As a sole trader, you use your personal tax file number and don’t need to get an additional one for the company.
Another advantage is that an individual can get a 50 per cent reduction in capital gains tax when selling a capital asset (such as from goodwill in the business) that has been held for at least twelve months. You will need an ABN regardless of the structure you choose. Find out how to get a sole trader ABN.
What are sole trader disadvantages?
One of the biggest ones is unlimited liability for the sole trader, including liability of all debts and no distinction between personal and business assets. When you set up a company it’s a separate legal entity, so it limits some personal liability.
There’s also limited growth capacity because there is a single founder and no partners. You can’t raise capital by offering shares of the business to investors. The more income you make, the greater your tax liability through progressive tax, unlike a company that can access flat company tax rates. All profit from the business is treated as personal income, so you have less flexibility when planning your tax.
It’s also more difficult to sell the business, especially as intangible assets such as goodwill are connected to you as the owner.
How do sole trader and company taxes differ?
The biggest difference is that the sole trader tax rate is the same as the personal tax rate (which gets higher the more your earn), while the company tax rate is 25 per cent for companies with under $50 million in annual turnover.
With both business structures you can claim a deduction for running expenses and other costs. When making sole trader tax deductions it’s important that you don’t claim personal expenses as business expenses. For example, when using a vehicle for business and personal reasons, you can’t claim all vehicle expenses as business expenses but need to proportion them according to use. So if 50 per cent of your vehicle use is for business, you can claim 50 per cent of expenses as sole trader tax deductions.
To avoid confusing business and private expenses and income, it’s important to set up a separate business banking account and use an accounting program to track your finances.
You will also be required to collect and pay goods and services tax (GST) once you reach the GST threshold of $75,000 turnover in a financial year.
When operating as a sole trader, you include a schedule of your business income and expenses as part of your personal income tax return. You also get the personal tax-free threshold of $18,200, so you won’t need to pay tax if you earn less than this amount.
Learn more from our Short Guide to Sole Trader Tax.
Consider business structures at the beginning
If you are considering starting a business, consider all the business structure options available. You can change your business structure later, but this can be costly and time consuming, so it’s a good idea to discuss your business and objectives with an accountant or legal advisor.
Check out our article on business structures that looks at the criteria for making a decision when setting up a business.