The term sole trader (also known as sole proprietor) is used for both legal and tax purposes. A sole trader is someone who runs and owns their own business in a personal capacity as opposed to operating a business through an entity such as a company or trust. While not necessarily implied by the name, a sole trader can in fact employ staff, however they cannot employ themselves. To learn about your tax obligations as an employer, in particular how PAYG Withholding and PAYG Instalments works, check out our article here.
The chief difference from a tax perspective between a sole trader and a company is that a company is a legal entity distinct from its owner, and must lodge its own tax return, whereas a sole trader only needs to lodge their own personal return.
The simplest way to set up a business is as a sole trader. You don't even need to register a business name, as you can trade under your own name. The key difference between operating as a sole trader and operating as a company is that as a sole trader, you as an individual are solely responsible for all aspects of the business.
If you are thinking about starting up a business and are unsure whether you should go down the sole trader or company route, you should get in touch with us to discuss your situation.
What do I need to do to register as a sole trader?
Obtain an Australian Business Number (ABN)
Unlike companies, sole traders aren't required to obtain separate Tax File Numbers (TFN) because they lodge their own income and expenses in their personal income tax return. If you wish to become a sole trader, however, you will need to obtain an Australian Business Number (ABN) in order to establish and operate a business in Australia.
Register for Goods and Services Tax (GST)
If you expect your sales turnover to exceed $75,000 per year or wish to claim fuel tax credits for your business, you will also need to register for Goods and Services Tax (GST). To learn more about GST and in particular, how to claim a GST credit, check out our article here. To learn more about how to claim fuel tax credits, check out our article here.
How much tax do sole traders pay?
The amount of tax sole traders pay depends on which tax bracket they fall into, as individual marginal tax rates apply. Remember, there is no difference between a sole trader's business income and their personal income meaning that sole traders only lodge the one personal income tax return.
You can consult the marginal tax rates in the following table to see how much tax you would be liable to pay before considering any deductions:
The taxable income tax for personal tax rates for the 2023/2024 financial year is as follows:
$0-$18,200 is nil
$18,201 - $45,000 is 19 cents for each $1 over $18,200
$45,001 - $120,000 is $5,092 plus 32.5 cents for each $1 over $45,000
$121,000 - $180,000 is $29,467 plus 37 cents for each $1 over $120,000
$180,001 and over is $51,667 plus 45 cents for each $1 over $180,000
Deductions available to Sole Traders
Small Business Tax Concessions
To be eligible for small business tax concessions as a sole trader, you will need to have less than $10 million in turnover in any given financial year.
Business Expenses Deductions
You can reduce your taxable income by claiming tax deductions on business expenses. These might include things such as tools and equipment, administration expenses, home office expenses, car-related expenses for business vehicles and more. For vehicle expenses, such as fuel, check out our article on claiming fuel tax credits here (insert link). Keep in mind that the Australian Taxation Office has rules on what can and can't be claimed as a business expense.
Capital Gains Tax
If you are a sole trader who has owned the asset for 12 months or more you can benefit from a 50% discount on your capital gains tax. There are also further small business CGT concessions.
Pros of paying tax as a sole trader
As sole trader income is personal income, sole traders benefit from the tax free threshold. There is no tax free threshold for companies, meaning companies pay tax on every dollar of income earned.
You only need to lodge the one tax return. As a company is a separate legal entity it is required to lodge its own tax return and pay tax on income. If you operate as a company you would have to lodge two tax returns, one personal and one for the company, and you may have to pay income tax twice. Given this, accounting fees and tax payable may be lower on the sole trader model.
There is a Small Business Income Tax offset of up to $1,000 per annum provided by the government. This is calculated based on the proportion of a taxpayer's total business net income compared to their total taxable income.
Sole traders are the cheapest business structure to set up and the most straightforward to manage.
Cons of paying tax as a sole trader
A company or a trust will potentially give you more options when it comes to asset protection or tax planning.
Tax tips for sole traders
The following five tax tips are very helpful for you to think about if you are considering becoming a sole trader:
You should keep separate bank accounts for personal and business use. This will make running your business and submitting accurate bank statements much easier and more cost efficient at tax time. It is also good practice for managing cashflow.
You should consider using accounting software to keep track of your income and expenses. We recommend Xero, which we use at Causbrooks.
You should make sure you understand the PSI rules (more on these below).
You should ensure you answer "Yes" to the question "Are you a small business entity" under Item 15 of your tax return to claim the Small Business Tax Offset.
You should put aside tax during the year so you have enough money to pay the tax bill at year end.
These tips are general in nature. If you have questions or think you might need personal tax advice, it is important to speak to a qualified adviser about your situation.
What is Personal Services Income and why does it matter?
As the name suggests Personal Services Income (commonly known as PSI) is a term that is used to describe or refer to income that is generated from the personal efforts of an individual (examples include, an HR consultant, accountant, or marketing expert), as opposed to profits generated from an asset (such as rent from a car or property), or from selling a product (such as from a retail shop), or from licensing your intellectual property (such as patent, or video training series).
PSI does not affect salary or wages that people earn as employees.
Why does PSI exist?
The government introduced the legislation that governs PSI in the year 2000 in an attempt to stop people from minimising tax by sharing income with family members or claiming deductions that would not be allowed if earned by a wage earner.
Will my sole trader business be affected by Personal Services Income?
Determining whether or not your sole trader business violates the PSI legislation is one of the most important things you need to do ahead of starting your business. To help you with this, work through the following 4 steps provided by the Australian Taxation Office (ATO).
Please note: if you can pass any of the below 4 steps you are not in violation of PSI. You do not have to pass all 4 in order for your sole trader business to comply with PSI.
Step 1 – more than 50% of your income is derived from personal efforts
Does more than 50% of your sole trader business income derive from the result of personal efforts? If the answer is yes, PSI may apply to you. If this is the case, move to Step 2 to see whether or not you are in danger of being caught in PSI.
Step 2 – the results test
Are you being paid for a result or for your time? To satisfy the results test, you must meet all three of the following conditions:
you are being paid at least 75% of your income to achieve a result (this includes being paid after achieving the result);
the risk to rectify any defects belongs to you;
you must provide all the necessary tools and equipment to complete the work relating to the above mentioned 75%.
If you meet all of the above conditions, it is unlikely that you will need to worry about PSI rules. If you are having trouble with completing the results test, ask yourself the following question: are you being paid on an hourly rate?
If you cannot satisfy the results test, you may be in violation of the PSI rules and should move to Step 3.
Step 3 – The 80% rule
The 80% rule asks if 80% or more of your income comes from the one client. Note, if you have multiple clients but they are associated with each other, be they subsidiaries, partners or trustees of related entities, then you must count the income as coming from one client.
If more than 80% of your income comes from one client (or associated clients), the PSI rules apply. If this is the case, move to Step 4.
Step 4 – The remaining tests
If you have answered yes to the first three steps, then you must pass at least one of the following three tests to avoid triggering the PSI rules:
unrelated clients test
To pass the unrelated clients test you must have work from at least two unrelated clients and obtain the work by advertising to the public, for example, via a website, or word of mouth. Note, any clients you obtain through a labour hire firm will be deemed related even if the clients aren't associated, so for the purposes of this test, even if you have multiple clients they will only be counted as one client.
To pass the employment test, you must employ others to complete at least 20% of your principal work (not support work such as administration tasks, but the work that is key to contract), or you need to have employed an apprentice for at least 50% of the year.
business premises test
To pass the business premises test you must have an office for your exclusive use throughout the whole year that is separate to your home or your clients' premises. You must also use the business premises to generate your personal services income for at least 50% of the time.
Business premises that do not pass the test include:
leasing a desk in a shared working space (this is not exclusive use of the business premises)
a home office (as it is not separate from your residence)
leasing an office for part of the year (unless you only commenced trading during the year, and you leased or owned the office throughout this full period)
If you are still unsure whether the PSI rules apply to your situation after reading the above 4 steps, reach out to us.
What limits apply for tax deductions for Personal Services Income?
If the PSI rules apply to your situation, you will not be able to claim a tax deduction against the income for the following:
Occupancy expenses related to working from home. This includes: mortgage interest, rent, rates, land taxes, and insurance.
Payments, including super contributions, to family members for 'non-principal' support work, which includes things like administration tasks. If the family members' work is directly related to the principal work from which you derive your PSI income, then you are able to claim a deduction for payments made to such family members, and also for other wages for support work by a non-associate.
If the PSI rules apply to your situation you must complete Item 14 - Personal Services Income when preparing and lodging your personal individual tax return.
While becoming a sole trader is the simplest and potentially least expensive way to start a business, there are considerable responsibilities that come with it, including tax and compliance considerations, so you should make sure you are aware of and understand the risks involved.
If you would like more options when it comes to asset protection or planning, you may want to consider operating your business through a company or a trust.
While you can prepare and lodge your own tax return as a sole trader, many sole traders use a registered tax agent, as they tend to be adept at picking up on missed deductions and are able to provide tax strategies and ensure you remain compliant. If you are having trouble preparing your sole trader tax return, reach out to us.
Causbrooks gives you a client manager supported by a team of knowledgeable small business experts. We’re here to take the guesswork out of running your own business.
Get in touch with us to set up a consultation or use the contact form on this page to inquire whether our services are right for you.
Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.