How does business structure affect sole trader tax?
The business structure you choose will have a big impact on whether you pay sole trader tax. Most importantly, the tax rate and tax-free threshold will be different if you decide to form a company.
When you register a company, you create a separate legal entity and the costs are significantly higher than for a sole trader. Keep in mind that you can still have a separate business name when you are a sole trader, but you are trading as that business name and not a separate entity. You will need to register that business name with ASIC.
Learn more about the differences between a sole trader and a company.
Tax differences between the two structures
Here’s a quick summary of the main differences between tax obligations for the two business structures:
|Tax-free threshold||In the 2020-2021 financial year, this amount is $18,200. This is the personal income tax rate.||There is no tax-free threshold for companies, so every dollar of profit is taxed.|
|Tax rates||Individual tax rate (outlined in the next section).||These are between 27.5% and 30%, depending on the company.|
|Lodging tax returns||Sole traders lodge individual tax returns.||Company tax return must be lodged each year. Company directors or employees also need to lodge individual tax returns.|
What are sole trader tax rates?
Sole traders file income taxes as individuals, so they pay personal tax rates. Income is determined after making deductions from business income. The rates are:
|Taxable income||Tax on this income|
|0 – $18,200||Nil|
|$18,201 – $45,000||19 cents for each $1 over $18,200|
|$45,001 – $120,000||$5,092 plus 32.5 cents for each $1 over $45,000|
|$120,001 – $180,000||$29,467 plus 37 cents for each $1 over $120,000|
|$180,001 and over||$51,667 plus 45 cents for each $1 over $180,000|
These sole trader tax rates don’t include the Medicare levy of 2%.
How do I complete a sole trader tax return?
Sole traders submit individual tax returns along with a schedule of business income and deductions for expenses. Some sole trader tax deductions include:
- Operating expenses – also called running expenses, these include rent, legal or accounting fees, marketing, inventory costs, marketing, sales or sales commission, insurance, payroll and travel expenses.
- Vehicle expenses – if you use a vehicle in the business, you can deduct part of the expenses based on cents per kilometre or the logbook method. This will depend on the percentage of vehicle use for business and other factors.
- Work from home expenses – if you run a sole trader business from home, you can deduct expenses for this. Check out the ATO’s Claiming a tax deduction for expenses for a home-based business for more information.
- Instant asset write-off – under this program, you can claim the full amount of an asset as a tax deduction in the financial year it was purchased, delivered and installed. Learn more about using the instant asset write-off.
If you are confused about paying tax as a sole trader, including how to separate business and private expenses, consulting a professional bookkeeper or tax accountant will help you get it right concerning sole trader tax rates and sole trader tax returns.
What is Pay As You Go (PAYG) tax withholding?
Pay-as-you-go instalments are an important part of a sole trader’s tax obligations. Instead of paying all your income tax after the end of the financial year (which can be an unpleasant surprise for many small businesses), you pay in instalments that split your estimated income tax over four payments throughout the year.
If you are new in business, you can nominate the instalment amount based on what you think you will earn in the year. For established sole trader businesses, the ATO bases PAYG instalments on the previous year’s income.
Do I need to collect and pay Goods and Services Tax (GST)?
GST needs to be addressed by all sole traders. The first question to answer is whether or not to register for GST, as businesses with less than $75,000 in annual turnover are not required to collect and pay GST to the ATO.
When you register for GST, you have to add this tax (10%) to all your invoices. This amount, minus any GST you have paid for business expenses, must be paid to the ATO.
For example, let’s say you are registered for GST and took in $33,000 in revenue (including GST) in the financial quarter and you had $11,000 in expenses (including GST) in that quarter as well. You collected $3,000 in GST and paid $1,000 in GST, so you owe $2,000 to the ATO.
If you were not registered for GST, you would not charge customers or be able to claim back GST for expenses. So you would have taken in $30,000 and paid $11,000 in expenses (since you have to pay GST on your purchases even if you don’t collect it from your sales).
Given that you are taking it $30,000 in one quarter, you will likely surpass the $75,000 annual threshold requiring you to collect and pay GST.
Find out more in When Should You Register for GST?
How do I get started with sole trader tax if I’m beginning in business?
If you’re starting out as a sole trader, setting up your bookkeeping right will simplify the process. This includes using an online bookkeeping solution such as Xero, Quickbooks and MYOB. Many of these solutions have smartphone apps that make it possible to manage your books from anywhere and provide access to a bookkeeper. Learn more in 18 Powerful Smartphone Apps to Help You Run Your Business.
Getting professional assistance early is also an important step to avoid the stress of managing your sole trader tax. A bookkeeper can help you set up and manage your accounts. When approaching tax time, a tax agent or accountant can help you with your sole trader tax return. Learn more in Six Questions to Ask Before Hiring an Accountant.