While this guide will help you get to grips with the key considerations, as always, be sure to seek professional advice specific to your business and personal circumstances.
In short, registering as a sole trader is the simplest way to launch a business, and as an added bonus the ongoing paperwork is minimal. It’s easy to see why this structure is a popular choice for those starting out as a freelancer or tradesman. However, it’s important to understand the limitations, tax rates and additional personal liability you will incur as a sole trader.
On the other hand, if you plan to grow a substantial business over time, involve shareholders and reduce your personal liability and tax rates, then a company structure may be the better option.
It’s worth noting too that your business structure is not set in stone, you can always change depending on your circumstances at the time. Having said that, making the right decision from the get-go could save you a headache and extra paperwork down the track.
Let’s examine some of the key differences.
The cost to getting started
There are differences in start-up costs, while they may be negligible in the long run it could be a consideration for many when trying to get your business off the ground. There aren’t a lot of up-front costs involved when starting your business as a sole trader. Getting yourself an ABN is free and is very simple to obtain.
You may choose to register a business name which attracts a $36 fee for a single year or you can score yourself a discount and register for 3 years at $84.
As of 2018 Registering a company will cost you $488 on top of the business name registration (same fees as sole traders). There is also an annual review fee that will set you back $263.
For all the possible fees associated with running a company see this fee index article from ASIC.
Liabilities and business debt
This is one of the larger and more important differences between a sole trader and a company. Understanding your liability and what it means for you personally is crucial.
As a sole trader you are personally liable for all financial and tax debt your business incurs. This also means there is no distinction between personal assets and business assets. Things like your home and car can be used to repay any outstanding debt in your name.
A key advantage of a company structure over a sole trader is the ability to limit your personal liability. This is not a “get out of jail free” card, especially if you are a director of the company. For further reading be sure to check out this excellent table from business.gov.au which compares the liability of sole trader vs a company in finer detail.
When it comes to tax, sole traders and companies are viewed differently by the ATO.
Paying tax as a sole trader is simple, they are taxed the same way and at the same rates as an individual. We’ve previously written a handy article on tax for sole traders which explains income tax and GST in some more detail.
Individuals enjoy a tax-free threshold which is set at $18,200. Currently the highest possible tax rate for an individual is 45%. This high rate applies to every dollar earned over $180,000. For the full tax rates for this and previous financial years view the individual income tax rates on the ATO’s website.
Companies generally pay a flat rate of tax for every dollar earned (there is no tax-free threshold).
Currently there are two rates; if your company earns less than $10 million per financial year then the company tax rate is 27.5%. For companies earning above the threshold the rate is increased to 30 cents in the dollar.
Both sole traders and companies are able to employ staff and are required to obtain workers compensation insurance. Adding a member to your team is very exciting, just make sure you understand your tax super and payment obligations and your employees entitlements.
Paperwork and ongoing costs
As you might expect, the simpler the business structure the less demanding the paperwork, reporting and ongoing costs will be.
In terms of ongoing paperwork, the two key reports that need to be lodged with the ATO are an individual tax return and a business activity statement (BAS). Keep in mind that lodging a BAS is not always necessary if you’re not registered for GST. To learn more about GST and if you should register, check out our guide to registering for GST.
Records must be kept for at least 5 years, either paper records or electronic will keep the ATO happy. Using Rounded, our accounting software for sole traders, makes record keeping super simple and automated in most cases.
Ongoing costs are again minimal, if you have registered a business name it’ll set you back just $36 per year.
A company is the more complex of the two structures and the ongoing paperwork and ongoings are naturally higher. A company must lodge an independent tax return in addition to your individual return and must keep financial records for a minimum of 7 years.
A separate bank account is also mandatory for companies. The fees and level of paperwork required will vary by institution.
Companies are subject to an annual review by the Australian Securities and Investments Commission (ASIC) which attracts a $263 fee.
Choosing a business structure depends not only on your initial ambitions but also where you see yourself and your business in a few years down the track. Sole traders enjoy a lot of simplicity upfront but may miss out on some of the benefits of a fully-fledged company.