Are you about to make one of the most common mistakes entrepreneurs make? Choosing the wrong business structure.
Whether you decide to operate as a sole trader or register as a company, this decision can make or break your success down the line.
It’s more than just paperwork and formalities. It is about protecting your personal assets, paying the right amount of tax, and setting yourself up for success. Before you dive in, let’s make sure you’re on the right path.
Sole Trader
A sole person who runs and is responsible for controlling and managing a business is called a sole trader. From day-to-day operations to strategic planning, all decisions are taken by this individual.
This structure is the simplest of all and is also the most affordable. But, since there are no legal distinctions between the individual and the person in this structure, the owner becomes personally liable for the business. As a result, this structure becomes one of the riskiest options.
In simpler terms, if the business faces legal issues or financial struggles, the personal assets of the owners could be at risk of settling those debts.
Pros & cons of being a Sole trader
What are some of the advantages of being a sole trader?
Cost-Effective Setup and Maintenance
Establishing and running a business as a sole trader is generally less expensive compared to other business structures. The initial setup costs are lower, and ongoing administrative expenses are minimal.
Simplified Tax Reporting
As a sole trader, you only need to file a single tax return, which simplifies the tax process. This can reduce the time and cost associated with tax compliance.
Complete Ownership and Control
Being a sole trader means you have full ownership, control, and management of your business. This autonomy allows you to make decisions quickly and independently, aligning your business to your vision and goals.
Tax Benefits for Low-Income Businesses
If your business generates a lower income, you may be eligible for certain tax benefits. These can help reduce your overall tax burden and improve your financial standing.
No Workers’ Compensation Requirements
If you do not employ any staff, you are not required to pay workers’ compensation insurance. This can result in significant cost savings for your business.
No Superannuation Contributions on Drawings
As a sole trader, you are not obligated to make superannuation contributions on the money you draw from the business. This provides additional flexibility in managing your finances and personal income.
Now, let’s move on to some of the disadvantages you must consider:
Risk to Personal Assets
As a sole trader, your personal assets are not protected if your business incurs debt. This means that creditors can go after your personal property, such as your home or car, to settle business liabilities.
Limited Tax Planning Flexibility
Sole traders have fewer options for tax planning compared to other business structures. This can result in higher overall tax liabilities, especially as your business grows and generates more income.
High-Income Tax Challenges
Businesses that generate a high income may find it challenging to minimise their tax burden. Sole traders have limited avenues for tax deductions and credits, which can lead to higher taxes on substantial earnings.
Difficulty Retaining High-Caliber Employees
Attracting and retaining top talent can be challenging for sole traders. Without the ability to offer shares or partnership opportunities, it may be harder to incentivise and keep skilled employees.
Growth Limitations
Sole traders face limitations in expanding their business. You cannot bring on partners or co-founders, which can restrict the business’s capacity for growth and innovation.
Profit Retention
While keeping all profits might seem advantageous, it also means that all financial responsibilities and risks rest solely on you. This can be overwhelming and financially draining, especially during tough times.
Business Continuity Issues
The business is closely tied to your personal circumstances. If you retire or pass away, the business typically ceases to exist. This lack of continuity can impact long-term planning and stability.
Proprietary Limited Company
A proprietary limited company, or Pty Ltd, is a type of business structure that functions as its own legal entity. This means that the company itself has rights and responsibilities separate from the people who own or run it. Essentially, it can sign contracts, own property, and engage in legal matters on its own
With a Pty Ltd structure, you can have up to 50 shareholders, and the ownership can be easily transferred through the sale of shares. This makes it a flexible choice for businesses looking to grow or change ownership over time.
However, it’s important to note that setting up a Pty Ltd company comes with costs, such as registration fees. It also requires ongoing compliance with regulations, which can increase your administrative workload.
Overall, operating as a Pty Ltd company can boost your business’s credibility. It can give your company a more stable and permanent appearance. This can be especially helpful when you’re trying to attract investors or build trust with customers.
Pros & Cons Of Running a Company
Let’s look at the advantages of running a company.
Protection of Personal Assets
Running a company comes with some great perks, starting with the protection of your personal assets.
Since the company operates as a separate legal entity, it stands apart from your personal finances. This means your personal assets (like your home or savings) are protected from any financial trouble the company might face.
As a result, you won’t risk losing your personal belongings if the company hits a rough patch.
Flexibility in Tax Planning
Another benefit is the flexibility in tax planning.
Companies have several options for managing their taxes. They can take advantage of various deductions and incentives that may not be available to other business structures.
This can help you keep your tax bill in check and save money.
Employment of Shareholders
Companies also have the ability to employ shareholders, which can be a great way to attract and keep talented individuals. Shareholders who work for the company can receive salaries and other benefits, aligning their interests with the company’s success.
Ease of Ownership Transfer
Ownership transfer is another advantage. It’s relatively easy to sell or transfer shares, which makes it simpler to bring in new investors or transition ownership when needed.
Simplified Capital Raising
Raising capital is more straightforward for companies, too. By issuing shares, companies can attract investment to support their growth and expansion. This can provide a significant boost for the business.
Favourable Tax Rates
Lastly, companies often enjoy more favourable tax rates.
Depending on your location, corporate tax rates can be lower than personal income tax rates. This difference can enhance profitability and offer financial benefits.
Are there any disadvantages?
Higher Setup and Maintenance Costs
Running a company comes with its own set of challenges. For starters, setting up and maintaining a company can be more expensive compared to other business structures. You’ll face costs such as registration fees and ongoing regulatory compliance, which can add up over time.
More Time-Consuming Tax Filing
Another downside is that managing taxes can be more time-consuming. Companies need to file separate tax returns, which means more paperwork and complexity compared to simpler business structures. This added workload can require additional time and resources.
Complex Winding-Up Process
If you ever need to wind up the business, it can be a slow and costly process. Liquidating a company involves several legal and administrative steps, which can take a lot of time and incur significant expenses.
Tax on Distributed Profits
Lastly, profits distributed to shareholders are subject to taxation. This means that while the company may benefit from favourable tax rates, any money distributed to shareholders will be taxed again. This double taxation can impact the overall returns.
Sole Trader vs Company
Set Up Cost
Sole traders have a simple setup process. They don’t need an ACN or to register with ASIC, which keeps costs low. A separate business bank account is optional, so you can avoid extra bank fees if you choose.
For a company, you’ll need to register with ASIC, which costs $576 in 2024 to get an ACN. A separate business bank account is required, and fees may apply.
Tax
Sole traders are taxed as individuals, meaning their business income is reported on their personal tax return and taxed at their income tax rate.
A company, however, files its own tax return and is taxed as a separate entity. It has no tax-free threshold, so all earnings are taxed from the first dollar.
Income
For sole traders, all business earnings are treated as personal income. Deductions can be claimed for business expenses.
In a company, earnings belong to the company. Directors can be paid through wages, dividends, or shares.
Ongoing Costs
Sole traders face minimal admin and costs, as their business income is included in their personal tax return. No need for a separate business tax return.
Companies tend to have higher ongoing costs due to their complexity. They also require two tax returns: one for the company and another for the individual owner.
Liability of Debt
Sole traders are personally liable for business debts, meaning personal assets could be used to cover any losses.
In a company, the business itself is responsible for debts, and keeping personal assets protected.
Business Longevity
A sole trader’s business typically ends if they pass away.
A company can continue operating even if the director passes, as ownership can be transferred.
So which one is better?
Choosing between a sole trader structure and a company really depends on your specific needs and long-term goals. If you’re looking for a simple, low-cost setup with minimal admin, being a sole trader might be the better option.
However, if you want better asset protection, more opportunities to raise capital, and flexibility for growth, a company structure could be worth the extra effort and expense.
Every business is different, so it’s important to weigh the pros and cons of each structure carefully.
If you’re still unsure, our team at Clear Tax Accountants can help you make the right decision for your business. Contact us today to discuss your options!
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