Are you a café owner? Maybe you run your own online business on platforms like Etsy or eBay? In the eyes of the ATO, you are likely to be a sole trader. That means you are an individual that runs and owns the entire business and pays sole trader tax on profits earned. Due to the lack of government regulations, sole trade is one of the simplest and most inexpensive business arrangements to establish.
If you operate your business as a sole trader, you’ll be legally responsible for all aspects of the business. Whether your business is making profits or taking losses, it can’t be shared with other individuals. You don’t need to create a separate business or trade name. You can start a sole proprietorship under your own name.
The actual definition of ‘sole trader’ refers to the legal structure of the business, rather than the number of employees. That means that you can also employ workers in your business.
Key Features of a Sole Trader
The main features of a sole proprietorship are listed below:
- One person ownership
- No separate business identity
- The owner owns everything the business owns
- Unlimited liability
- No special legislation
- All profits and losses to the sole trader
- Fewer formalities
- Minimum government regulations
- Flexibility of organization
- Easy and affordable setup
Information About Personal Services Income (PSI)
If you offer products and services based mainly on your personal skills, knowledge, time, and labour, then you’re earning Personal Services Income (PSI). Being a sole trader, it’s vital to understand if you earn PSI so you can know what tax deductions to claim.
How To Register as a Sole Trader?
In Australia, becoming a sole trader is quite simple and easy. Here is the step-by-step process of setting up as a sole trader in Australia.
- Set up and register a business name.
Note: There is no need to set up a business name if you’re using your personal name for the business.
- Apply for an Australian Business Number (ABN)
- Register for Individual Tax File Number (TFN)
- Register for Good and Services Tax (GST)
- May opt for the Pay As You Go tax instalments if you want to spread your tax instalments throughout the year
- Apply for license and registrations
- Purchase your own insurance coverage
Tax For Sole Traders
When you work as a sole trader, you become responsible for managing your company taxes. It’s therefore vital to understand what tax you can expect to pay if you’re self-employed or run your own business in Australia. Here are the taxes you might be accountable for if working as a sole trader in Australia.
- Income Tax
It is the tax imposed on an individual or entities in respect of the income or profits earned by them. Whether you’re running your own business or working for somebody else, you have to pay income tax, but the rates vary depending on how much you earn annually. Sole traders pay the same individual rates as employees, and the specific rates depend on your total earnings.
So, what is taxable income? It refers to the amount of income used to calculate the taxes owed by you as a sole trader. Generally, it includes some or all items of income and is reduced by expenses and other deductions. You can file your annual income tax return through the ATO’s website.
- Goods and Services Tax (GST)
Good and Services Tax (GST) is an indirect tax levied on most goods and services sold or consumers in the country. GST is charged at a rate of 10%. If you’re a sole trader with a taxable turnover of $75,000 or more, you’re required to register for GST.
Understanding PAYG Instalments and How They Help
PAYG instalment is a system for making regular payments towards your expected annual income tax liability. Once the income reaches a certain level, the ATO will automatically put you into the Pay as You Go instalment system.
If you’re a sole trader, PAYG instalments help you keep your cash flow healthy and business afloat. Moreover, it helps you to avoid a large tax bill by making regular payments throughout the year.
Business Activity Statements (BAS)
If you’re a sole trader and your business is registered for GST, then you need to lodge a Business Activity Statement (BAS). It is basically a form that is submitted to the Australian Taxation Office (ATO). Your BAS will help you report and pay for GST, PAYG instalments, PAYG withholding tax, and other taxes.
Tax Tips for Sole Traders
Here are a few top tax time tips for sole traders:
- Know your Tax Obligations
- Assess for PSI
- Don’t Miss out on Deductions
- Be a Strict Record Keeper
- Understand the Basics
- Superannuation Contributions
- Small business income tax offset
- Small Business Restructure Rollover
1. Know your Tax Obligations
As a sole trader, you must be aware of the different tax obligations you might be accountable for. The two main taxes a sole trader has to pay are Income Tax and Good and Services Tax (GST). Exactly how much income tax you pay depends on how much you earn annually. You need to pay the same individual rates as employees, and the specific rates depend on your total earnings. Besides, if your turnover is more than $75,000, you’re liable to pay GST.
2. Assess for PSI
PSI is income produced mainly from your personal skills or efforts as an individual. It’s classified as PSI only if the income generated from your labour, skills and expertise is more than 50%. PSI is not specific to any particular industry, profession or trade. You could be a copywriter, management consultant, hairstylist, financial professional or similar.
It’s important to understand Personal Services Income PSI and its implications since it affects the amount of tax you pay as a sole trader. If PSI rules don’t apply to you, then you may be able to access more deductions and reduce your tax bill.
3. Don’t Miss out on Deductions
As a sole trader, it’s important to know exactly what you can claim because it can help you keep off large tax bills when tax time looms. According to the ATO, you can generally claim the following expenses in the year you incur them:
- Business travel expenses
- Advertising
- Home office expenses
- Business motor vehicle expenses
- Bad debts and outstanding expenses
- Prepaid expenses
- Education and training
- Utility bills
- Professional memberships
- Interest and insurance
- Repair and maintenance
- Other expenses including banking, accounting, stationery, relevant courses and subscription.
4. Be a Strict Record Keeper
Organising your records and setting up good recordkeeping practices throughout the year will help you save a lot of time and efforts as a sole trader. You should hold on to every purchase, sales, expense and bank records. You’ll also need to maintain accurate records of your accounts receivable and accounts payable.
For fast and easy recordkeeping, you can leverage advanced cloud-based accounting software. With accounting software, you can keep all the relevant information safe within the cloud. Therefore, retaining records will be simple, and you will have all the accurate information to hand when the tax return deadline approaches draw near.
5. Understand the Basics
While you can file your tax return through a registered tax agent or by filling out a paper form, one of the best ways is to prepare and file it online with the Australian Taxation Office. While completing your return, utilize the designated segment for business items to show your income and expenses — there isn’t a separate form for sole traders so you’ll simply use the individual return form.
6. Superannuation Contributions
Considering your superannuation contributions as a sole trader can help you build your retirement savings and low your tax bill. If you’re a sole trader, you still have an obligation to pay the super guarantee (SG) currently 9.5 per cent. There are lots of options to make self-employed super contributions to your superannuation, which may give you both tax benefits and help build your wealth.
7. Small business income tax offset
If you want to reduce your tax by up to $1,000 each year, a small business income tax offset can help you. You must be carrying on a small business as a sole trader to become eligible for a small business income tax offset. You are only entitled to the offset if your net small business income is a profit.
8. Small Business Restructure Rollover
The small business restructures rollover allows sole traders to transfer active assets from one entity to one or more other entities. The purpose of the small business restructure rollover is to permit closely held groups to restructure their assets without consequences under the federal tax legislation. State-based taxes may still apply to such a rollover. GST may also be applicable. Broadly, if the rollover provisions apply, the income tax legislation (including capital gains legislation) is “switched off” concerning the transfer of the assets.
| Differences | Sole Trader | Company |
|---|---|---|
| Tax Rates | A sole trader is taxed through the personal tax return of the owner. The taxable income for 2020-21 started with $18,201. | Company tax rates apply to companies, corporate and public unit trusts. The full company tax rate of 30% applies |
| Tax-free threshold | A sole trader will be able to claim the tax-free threshold of $18,200 in the 2020-21 financial year | Companies have to pay tax on their annual revenue as there is no tax-free threshold for them. |
| Lodging tax returns | Most individuals need to prepare and lodge a tax return each year | Companies also need to lodge a tax return. The company reports its taxable income, tax offsets and credits, PAYG instalments and the amount of tax it is liable to pay on that income. |
| Capital gains tax (CGT) | Capital Gains Tax is a tax paid on any profits made when selling or ‘disposing’ of all or part of a business asset. You may be able to reduce the capital gain through various methods that you can see on ATO’s website. | Generally, companies do not use discount methods to calculate capital gains, although it can apply to a limited number of capital gains made by life insurance companies. Companies can use the indexation for calculating their capital gain if they meet the condition of this method. |
Closing a Sole Trader Business
If you’re a sole trader and wish to close your business, here are several steps you can take to accomplish this. The process is very simple and you don’t even have to do anything in some cases.
- If you have a product business, reduce or eliminate inventory
- If you run a service business, it is a good idea to provide quality service until the end. You can also provide a referral to other professionals
- Cancel your Australian Business Number (ABN) and Individual Tax File Number (TFN)
- Cancel your license
How Can We Help?
Get the help you need with choosing your type of business structure with Accumulus Advisory. When you first start a business, your mind may be swimming with an endless number of tough decisions to make. As each type of business structure has its own requirements, Accumulus Advisory can offer guidance that will ensure you make the right choice!
Before you decide on which structure is the most appropriate for your business, reach out so we can help you get started on the right note.
