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Understanding Tax Differences: Sole Trader vs. Company Structure

As a sole trader in New South Wales contemplating the next growth phase of your business, one critical decision you’ll face is whether to transition your business structure from a sole trader to a company.

This decision can significantly impact your tax obligations and financial planning.

At Lift Accounting & Advisory, we’re here to help break down these differences in a straightforward manner, ensuring you’re well-equipped to make an informed decision.

Taxation for Sole Traders

As a sole trader, your business’s profits are treated as your personal income and taxed according to individual income tax rates.

This structure is simple and straightforward but comes with progressively higher tax rates as your income increases.

Income Tax Rates:

As of the current tax year, the individual tax rates range from 19% for incomes over $18,200 to 45% for incomes exceeding $180,000. This means that as your business grows and profits increase, you could find yourself in a higher tax bracket, leading to a larger tax liability.

Medicare Levy:

Additionally, sole traders are subject to a Medicare Levy of 2%, which is applied to your taxable income if it exceeds a certain threshold.

Tax Deductions and Claims:

Sole traders can claim deductions for most business-related expenses directly against their income, potentially reducing their overall taxable income.

Taxation for Companies

Switching to a company structure means that your business is considered a separate legal entity and is subject to corporate tax rates, which differ significantly from personal tax rates.

Corporate Tax Rate:

In Australia, the full company tax rate is 30%, but a lower rate of 25% applies to companies classified as base rate entities (i.e., those with an aggregated turnover of less than $50 million and that earn no more than 80% of their income in passive income such as rent, interest, and dividends).

Double Taxation:

One important aspect to consider is the issue of double taxation. Profits taxed at the company level may also be taxed again when distributed as dividends to shareholders unless franking credits (tax paid by the company) are attached to those dividends.

Tax Deductions and Asset Protection:

Companies enjoy broad deductions similar to those available to sole traders but benefit from greater flexibility in tax planning and asset protection strategies.

Key Differences and Considerations

1. Liability and Risk:
As a sole trader, your personal assets (such as your family home) are at risk in case of business failure. In contrast, a company structure provides limited liability, protecting your personal assets from business debts or legal actions.

2. Administrative Requirements:
Operating as a company comes with increased regulatory and administrative responsibilities, including stricter reporting requirements and higher compliance costs.

3. Superannuation Obligations:
Sole traders must make their own superannuation contributions, whereas companies must contribute on behalf of their employees, including directors and other eligible workers.

4. Future Growth and Investment:
A company structure that clearly separates owners (shareholders) and business operations might be more favourable for attracting investors and supporting broader business growth.

Deciding Which Structure Suits You

The choice between remaining a sole trader or transitioning to a company depends on multiple factors, including your business’s profitability, growth prospects, personal risk tolerance, and long-term business goals.

Transitioning to a company might make sense if:

  • You’re concerned about personal liability.
  • Your business is growing, and you expect to retain profits within the business to fund future expansion.
  • You’re looking to project a more professional image to clients, investors, or partners.

Switching from a sole trader to a company in NSW is a significant decision that impacts your tax obligations, personal liability, and the way you conduct your business.

At Lift Accounting & Advisory, we specialise in guiding sole traders through this transition smoothly and efficiently. Our experts are here to provide tailored advice based on your specific business circumstances, helping you structure your business optimally for tax efficiency and growth.

Feel free to reach out to us for a detailed consultation, and let’s map out the best path for your business’s future together.

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