The Pros and Cons of Operating as a Sole Trader
One of the fundamental decisions you will have to make after you have chosen to establish your own business is how you’ll legally structure it.
Operating as a sole trader is usually the most obvious way to organize a new business, and it remains the most prevalent form of new enterprise since it is straightforward to start up. However, before setting the decision in stone, it is important that you consider if this structure is appropriate for your current circumstances and whether it can support your long-term company goals. To assist you in making your decision, this article outlines the key benefits and drawbacks of working as a sole trader, as well as alternative company forms you may wish to consider.
Business Structure of a Sole Trader
A sole trader is someone who runs his or her own firm. When you start a business as a sole trader, the law regards you and your company to be one and the same. This means you’ll have entire ownership and management of the company, as well as all of its revenue and earnings. This does, however, mean that you are completely accountable for all of the company’s debts and that you are individually liable for any income tax on the money your company makes.
Consider the worse-case scenario: Your company is experiencing financial difficulties and is in debt. As a sole trader, the law considers both you and your company to be one legal entity. As a result, you may wind up paying off any business obligations with your personal funds.
Starting a Sole Tradership
As a sole trader, you can get your firm up and running quickly. You can trade using your individual tax file number (TFN) and an Australian Business Number (ABN). If you plan to earn more than $75,000 each year, you’ll also need to register for the goods and services tax (GST).
You should register your selected company name with ASIC if you wish to openly conduct your firm under a trade name rather than your personal name. Furthermore, if the business name is important to your brand, you should register it as a trademark with IP Australia.
As a business owner, you can also consider getting insurance like business insurance or public liability insurance. These provide a layer of protection for your business.
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You should be aware of the tax implications of starting your own business as a sole trader. Importantly, any gains from your business will be treated as personal income by the law. As a result, you must declare and pay income tax on your company income (after costs) using your personal TFN.
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You should also examine the following tax considerations:
If you are an Australian resident, you pay the same tax as everyone else and are entitled to the tax-free threshold. Furthermore, you are in charge of your superannuation plans. You may be entitled to deduct personal superannuation contributions, and must contribute to superannuation for any qualifying employees you hire.
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The Benefits of Being a Sole Trader
Most small businesses are structured as sole traders because it is by far the easiest and least expensive business form of business entity to establish. Furthermore, because the sole trader structure is inexpensive to start up, there are less legal and tax difficulties.
Other benefits of working as a lone trader include:
You have entire control, ownership, and management of the company. You also have the freedom to run your business as you see appropriate without the interference of other partners; solo traders are not bound by any specific restrictions. As a result, your reporting requirements are minimal; you keep any business profits after tax, as well as any money you gain after tax if you sell the business; tax losses can be offset against any other income you earn (subject to certain non-commercial loss rules); and If you earn money from the sale of a capital asset as an individual, you are entitled for a 50% capital gains tax deduction (subject to certain non-commercial loss criteria such as the goodwill component of a business).
The Cons of Working as a Sole Trader
For those just starting out, working as a sole trader might be quite enticing. However, it’s crucial to consider the drawbacks of this form of legal structure.
Most importantly, you are legally and financially liable for every part of the company. As a result, if there is a debt or obligation, your personal assets are at risk, and you do not have the option of sharing debts and losses with other company partners.
It’s also critical to recognize that there’s only so much room for expansion. One of the main reasons is that this structure prevents you from bringing on other company partners or co-founders. As a result, you may lose the capacity to communicate ideas and concerns with people that you would typically have while running a business. Similarly, while trying to expand and obtain funds for your firm, you won’t be able to sell shares in your company to investors. This implies you’ll have to look for funding from banks or other financial institutions.
Another crucial factor to remember is that there is no room for error when it comes to tax preparation. Basically, all corporate revenue is viewed the same as personal income. As a result, the higher your business’s revenue, the higher your tax burden. Unfortunately, you will not be able to take advantage of flat tax rates like those enjoyed by corporations.
Finally, when selling a firm, changing ownership is more complex. This is because valuable assets like goodwill are inextricably linked to you as a person.
Alternative Business Structures
Apart from functioning as a sole trader, there are two other options: creating a partnership or founding a corporation.
Forming a Partnership
In a partnership, all partners share ownership of the company and its assets. It also implies that debts are shared equally between the couples. As a result, there is room to split earnings and losses with those participating in the firm.
Starting a Corporation
A company is a legal body that exists independently of you and is regulated by ASIC. You can be more versatile in the following areas thanks to this division:
Managing your company’s affairs, sharing earnings, and safeguarding your assets are all important tasks.
It also reduces your personal liability for company debts and other obligations.