My Friends Often Ask Me…
Sole Trader Vs Company
Assuming you’re running a business (and not just an employee), you may have asked the question:
Should I be a Sole Trader, or should I start a Company?
Here is a simple guide to help you make the right choice.
Being a Sole Trader simply means you run your business as yourself. So, you only need to lodge one tax return – your own! A Sole Trader believes in keeping things simple, and keeping things simple often means saving on compliance costs. Unfortunately, simple also means inflexible when it comes to trying to save tax. Depending on how successful your business is, you can get smacked with a tax rate of up to 49% of your business profit. This means less profit left over to re-invest in your business. Worse still, if your business goes broke, your personal assets (like your home) are up for grabs.
Running your business as a Company can make a lot of sense for two main reasons: Saving Tax & Asset Protection.
Operating your business as a Company allows you the flexibility to save tax a number of ways.
If your business profit is more than $80k, you can see significant tax savings if you run your business as a Company. This is because a Company pays tax at 30%, compared to 39% and even 49% for a Sole Trader (see my blog Am I Paying Too Much Tax?).
If your Business profit fluctuates from year to year, you could be paying more tax as a Sole Trader than if you ran your business as a Company. A Company allows you to pay yourself a wage, and effectively smooth out your business profit. This way, you can avoid the punishing tax rates in good years, and take advantage of low tax rates in lean years (see my blog Am I Paying Too Much Tax?).
And, any profit remaining in the Company will get taxed at a flat 30% (compare to up to 49% as a Sole Trader). So if your business is doing really well, and you want to re-invest as much of your profit back into your business instead of paying the Tax Man, it makes sense to operate your business as a Company.
If your spouse is not working, and you are both shareholders of the Company, your business profits can be shared between yourself and your spouse by way of a dividend from the Company. When a Company pays its shareholders a dividend, you get a credit for the 30% tax that the Company already paid. So if your spouse is not working, you can cash in over $6,000 tax refund every year from the Tax Man.
Running your business as a Company also gives you Asset Protection. This is because if something goes wrong, say the company is unable to pay its creditors, any liability in paying creditors is limited to the company’s assets – not yours. Those in high-risk industries are also afforded a level of comfort by operating their business as a Company. In cases of gross negligence though, you can still personally be sued for the actions of the company. If you are in a high-risk industry, or carry a large amount of creditors, a Company starts to make sense. This is irrespective of your business profit, and especially so if you own your own home or have other significant assets in your name.
A Company is comparatively more expensive than running your business as a Sole Trader. ASIC fees and accounting fees are par for the course, so a Company may not be for everybody.
So… Which do I Choose?
Choosing to run your business as a Company or as a Sole Trader requires weighing up the benefits versus the cost.
A Company is comparatively more expensive to run than a Sole Trader, but this cost can be money well spent depending on just how much tax you can potentially save, or how at risk you are with protecting your personal assets.
I often find that when a business is only just starting out, the reality is that cost minimisation is critical. There comes a time though when your business is doing well enough to justify trading as a Company. Yes, costs will be higher than being a sole trader, but the tax savings can far outweigh the cost. Additionally, the added piece of mind of asset protection can be a winning factor in deciding to run your business as a Company.
The guidelines above are a general rule of thumb to help you decide when to start a Company, especially if your intention is to re-invest in your business! As always, you should seek advice from someone who understands your own circumstances before making a final decision. If you would like to make the most of your tax-saving opportunities, and effectively manage your risks, contact Hansens today to speak with one of our Specialists.
Allan is a Tax Specialist with 15 years’ experience helping clients create wealth.
In next week’s blog, Allan discusses how using a Trust can benefit you.
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