Sole Trader to Company - when is the best time to change?
If you are operating a business as a Sole Trader, you may be thinking that the tax is getting a bit out of control and there must be a better way!
Changing tax structures to a company may be a way to reduce tax, but when is the right time to change?
Before jumping into a Company or any different structures, you will need to determine what structure is right for your business. To help you decide, this is a great tool available from the Government.
https://register.business.gov.au/helpmedecide
Tax Benefits of changing from a Sole Trader to a Company
First, lets look at the Company Tax Rate. A Base Rate Entity is a company that has an aggregated turnover of less than $50 million and has less than 80% of its assessable income from passive income. Base rate entities are entitled to apply a lower company tax rate of 25%, rather than 30% for companies that do not qualify as a base rate entity.
Companies are liable to pay tax from the first $1, and do not have a tax free threshhold.
In contrast, Individuals have access to a tax free threshhold of $18,200 and there is a sliding tax scale according to their taxable income. Income tax rates start at 19% plus Medicare for income earnt over $18,200, with income over $180,000 attracting the maximum tax rate of 45% plus Medicare.
So, what is the point when it is best to change to a company?
For 2023, we have calculated the optimum point where it is worth changing to a company:
- Once an individual earns $100,344, if they have private health insurance, the tax payable will be $25,085.68 (including medicare)
- The company with an income of $100,344 will be paying $25,086.00.
- Therefore, the point where an individual should think about changing to a company structure, is when the taxable income exceeds $100,344.
- NB: this is a guide only and does not take into account any offsets that may be available, and does not reflect every individual’s personal circumstances.
Basing your decision to change to a company structure purely on tax benefits is fraught with danger if you do not take into account other considerations.
Sole trader Vs Company – other considerations
These are some of the differences between operating as a sole trader vs operating as a company, and should be considered besides just the tax benefits:
1. Set up costs
Sole trader – Operating as a sole trader involves minimal costs. If a sole trader wants to trade under a different name than their own, they will need to register a business name which is currently $37 for 1 year and $87 for 3 years. Opening a separate bank account for the business may incur bank charges.
Company – Registering a company involves more formalities and legal requirements. To set up a company, the ASIC registration fees are from $512, but it also wise to consult with an Accountant to help with structure planning and compliance, which will incur extra costs. Opening separate bank accounts for the company may incur bank charges.
2. Record keeping
Sole trader – As a sole trader, the business income and expenses are reported in their personal tax return in a separate Business schedule. Generally, the record keeping is less complex than that of a company.
Company – Companies have more extensive record keeping requirements. They need to lodge their own tax return, separate from the tax returns of the owners or directors. They are required to maintain accurate and detailed financial statements that show the financial position and performance of the company. These statements need to be prepared according to accounting standards and must provide a true and fair view of the company’s financial position. Accounting fees with cost more due to the additional compliance work involved. Additionally, companies are subject to an annual review by ASIC, which currently costs $310.
3. Business Income
Sole trader – The money a sole trader earns from a business is treated as the individual’s income. As business income is reported in an individuals’ tax return, the individual is required to pay any taxes owing.
Company – The money a company earns belongs to the company, even if the director is performing the work. A director can draw wages or directors’ fees, but cannot take personal drawings from the bank account unless a loan agreement is made. Additional costs are incurred when drawing wages, as superannuation and workers compensation are mandatory expenses.
4. Business debt liability
Sole trader – A sole trader is personally liable for business debts and personal assets can be used as a way to pay off the debts.
Company – The company is liable for business debts, however a director is often asked to sign Director’s guarantees for large asset purchases. Directors are also liable to the ATO for unpaid PAYG withholding and superannuation for employees.
5. Insurance
Sole trader – A sole trader may need insurance for personal injuries, disability and death as they are not covered by workers compensation.
Company – Employees in the company are covered by workers compensation insurance, which includes working directors.
The decision to change structures is complex and advice should be sought from an Accountant. Contact Ann to discuss your situation to see if the change to a company will be beneficial for you.
