One of the trickiest decisions small business owners have to make relates to how they should register their business. Is it better to enlist as a sole trader, or is registering as a company more suitable?
If you are facing a similar dilemma, remember that this decision will affect your business in the long run, especially regarding taxes. Also, take comfort that you are not alone in this difficulty, as it is a common problem encountered by most startup business owners.
Most importantly, you need to know that not everyone gets this decision right the first time. As such, this article will elaborate on the options to help you make the right call.
The Different Tax Effective Business Structures
There are four different types of business structures: sole trader, company, trust, and partnership. For beginners, you can choose between the sole trader or company options. However, you first need to understand how the two differ in terms of tax obligations and reporting.
Sole trader - It refers to an individual running a business. If you are looking for a cost-effective and straightforward way to set up your business, this is the structure for you. Sole traders report their business earnings through their individual tax file numbers. They are also liable for any tax debt, which is based on the standard marginal tax rates.
Company - Unlike a sole trader or a partnership, this business structure is a separate legal identity. If you take this option, know that you need to report company earnings independently. All of your income is also subject to a single company tax rate.
Respective Tax Obligations and the Process of Reporting
There are other considerations that you should take into account before making a final decision. The next section will show the minor differences between a sole trader and a company’s tax and reporting obligations.
On tax-free threshold
The tax-free threshold is the amount of income you can earn each year that is not taxed by the government. Sole traders can claim a tax-free threshold of $18,200 for the financial year of 2020 to 2021. Upon claiming it, they need to pay the rest of the tax as an individual.
On the other hand, a company has no tax-free threshold. If you go for this setup, you need to pay tax for every dollar your business earns.
On tax rates
As a sole trader, you can pay your tax at the individual income rate. The income tax bracket depends on your circumstances. The marginal tax rate usually starts from 19 per cent and goes up to 45 per cent. Small business entities pay 26 per cent income tax on their taxable profit.
On payroll tax
You can hire employees regardless of whether you are a sole trader or a company. If you do, you are required to pay tax on your employees’ wages.
On tax returns
The process of lodging tax returns differs for sole traders and companies. Sole traders need to do an individual return annually, while companies need to lodge a company tax return within the same period. For companies, this process includes reporting on income, deductions, and income tax that the owner is liable to pay.
On capital gains tax
Simply put, capital gains tax is the government fee on the profit you made from selling an asset. A sole trader can reduce capital gains through different methods: discount methods, indexation methods, or CGT concessions for small business.
On the other hand, a company cannot apply for the discount method. However, if your company meets the indexation method conditions, then you are free to use it.
On taxes and superannuation
The taxes and superannuation you need to pay and report will depend on your business activities.
If you have an annual turnover of $75,000 or more, you need to register for goods and services tax (GST). You also need to pay your income tax through PAYG (pay as you go) instalments.
If you have employees, you need to do the following:
Collect PAYG withholding amounts from the payment you give them
Report the withheld amounts to the Australian Taxation Office
Pay superannuation contributions for your employees
In case they receive fringe benefits, you need to pay for the fringe benefits tax too
On small business entity concessions
Every small business has access to different concessions. Owners can claim specific tax concessions for small businesses as long as they meet the eligibility requirements.
Consider all these responsibilities before you finalise what structure you will take.
Knowing the best business structure that works for you is vital before setting up a new business. If you structure your business specifically for tax purposes, you can maximise the tax benefits you will get every financial year. Doing so will also expose you to less stress and give you peace of mind.
Still not sure of what is best for your business? If you are planning to start an online business, consult with us at ECommerce Accountant. Our duty is to help online entrepreneurs minimise their tax liabilities and increase their profits. Contact us today so we can discuss your future!