Are you thinking of starting your own business?
Congratulations, that’s exciting! Operating as a sole trader is the simplest and most common business structure when starting a new business as it allows you to retain ultimate business control.
When compared to other business structures such as forming a partnership or a company, the setup is also easy and far less complex.
But with any business structure, you still have to understand what being a sole trader means for you legally.
Read along as we discuss what it means to be a sole trader: the advantages, disadvantages, the legals you need to think about and some frequently asked questions.
Let’s get into it.
What does it mean to be a sole trader?
Before we understand how to become a sole trader, let’s look at what a sole trader is.
Operating as a sole trader is very common for many small businesses. Yes, that’s right.
Being a sole trader applies to many industries, from musicians to shopkeepers, consultants, personal traders, and the trade business.
To put it simply, a sole trader is a business structure that applies to individuals. This means you are legally responsible for all aspects of the business and are accountable for any debts or losses.
In short, you will be running your business under your own name (personal name). So, the main features of a sole trader are:
- As a small business owner, you are your own boss, and you’re self-employed
- Unlimited liability– this means you are personally responsible for all the debts of your business
- Sole means trading alone and not using a company structure
- The owner is usually the manager of the business – You will have complete control over your business assets, business plans and business decisions
- You can use your individual Tax File Number (TFN) to lodge income tax returns
Unlike a company structure, you don’t need a separate business bank account. However, we recommend having a separate business bank account for operational reasons.
What are the advantages and disadvantages of operating as a sole trader?
Like any business structure, operating as a sole trader comes with ups and downs. The good news? We will tell you what these are so you’re prepared!
The key advantages are:
- Be your own boss – You are your own boss, company director, and you receive all business income
- Fewer set-up costs – The set-up costs are inexpensive, allowing you the best chances to launch your business
- Simple – It is simple and easy to establish your business for operations
- Private – Your business dealings remain private. That’s right; no one needs to know
- Tax benefits – If you are an Australian resident, the first $18,200 profit is tax-free and is taxed as part of your own personal income
- Winding up – You can easily wind up your business if necessary. For example, you if you want to pursue a different career path
- Changing legal structure – If your business is flourishing and rapidly growing, you can easily change the legal structure of your business. For example, you may consider having a partnership with your best friend
Here are some disadvantages to be aware of if you choose to be a sole trader:
- Loss of advantages – The sole trader structure is the cheapest to establish, but this advantage can be lost if your business rapidly expands
- Unlimited liability – You will be legally liable for your business’s debts when you register as a sole trader. Why? Sole trader business structures have unlimited liability. For example, your assets, such as your house, may be attacked for large debts or any shortfalls your business owes
- High tax later down the track – The Australian Taxation Office (ATO) requires sole traders to pay tax at a higher rate than companies. A sole trader tax rate of 42% will apply when the combined income exceeds $52,000, or at 47% if it exceeds $62,500
- Superannuation responsibilities – You will be responsible for setting up your own superannuation arrangements. However, you may be able to claim a tax deduction for personal contributions
- WorkCover does not protect sole traders
- No leave entitlements – Unfortunately, you are not entitled to sick pay or personal leave as a sole trader. So if there’s a situation where you’re not feeling the best, your business will have to continue to trade
How do I register as a sole trader?
Registering as a sole trader can be a simple task if you follow the proper steps. We have set out everything you need to know below.
- 1. Register Business Name – First, you need to register a business name. You can either set this up through Service NSW or register a business name with a verified ASIC business name through Lawpath
- 2. Register for an ABN – Secondly, you need to register for an Australian Business Number (ABN). Registering is a quick process, and Lawpath can help you do this, or you can register for an ABN through the Australian Business Register
- 3. Register for GST – Lastly, you need to register for Goods and Services Tax (GST). You can register for GST online, by phone or through your tax agent
Once you have completed the 3 steps above, you need to start thinking about a few other matters. For example, think about:
- The different contracts that you will have with customers and contractors
- How will you send invoices to your customers
- What sort of insurance your business will have
- Your taxation options – You can use your own TFN. Alternatively, if you follow step 2 and apply for an ABN, you can use this number for all your business dealings
- Paying yourself and all your employees
- Think about your own superannuation as well as your employees
Can I limit my liability as a sole trader?
The trickiest part of registering as a sole trader is that you will be personally liable for the debts of your business if something goes wrong.
However, there are ways to limit your liability as much as possible as a sole trader. How is this done, you ask? You can limit your liability by:
- Having insurance options in place
- Having a well-drafted contract
Let’s go through each option below.
Having insurance options in place is just one way to limit personal liability operating as a sole trader.
Why is this the case? It will protect not only you but the most vital assets in your business. One option you can apply would be to have professional indemnity insurance.
Say you’re a sole trader and want to open up your own accounting or law firm. Your day to day activities will involve providing advice to your clients, but what happens if this advice falls short and your client decides to take legal action against you?
This is where professional indemnity insurance can help. Professional indemnity insurance may protect you against the following situations:
- Protection against claims of negligence and malpractice – Professional indemnity insurance protects financial losses if a client takes legal action against you, including malpractice and negligence claims
- It will cover legal fees, as well as damages awarded against you
- Protection against professional misconduct claims
If you’re unsure how to draft your professional indemnity insurance, why not hire a Lawpath lawyer to help you prepare one, so you’re protected right away.
Having a well-drafted contract can limit your liability to your client, who is the person who has signed the contract.
The best way for you to limit your liabilities operating as a sole trader under a contract is by:
- Excluding liability through a liability clause
- Putting a financial limit on losses through a limitation of liability clause
- Exclusion of implied terms
- Warranties and indemnity for specific inclusions – If you have a contract with your clients, the agreement will limit your liability to your client
If you need assistance in creating a well-drafted contract that will include all the clauses listed above, our lawyers can be of help.
How do I get paid as a sole trader?
One fundamental difficulty operating as a sole trader is receiving payments on time.
The best way to get paid as a sole trader is to send invoices to your clients after completing a task. An invoice will cover the terms, conditions and prices you require.
However, what is your option if your client doesn’t pay you on time or even pay?
This is where you can use a Letter of Demand to chase payments from your clients. Sending a letter of demand will warn your clients that you demand payment for the outstanding money, and it’s the final opportunity before you take matters further.
Ideally, sending a Letter of Demand should be your last option as it may cause operational problems for your business.
Having a contract that sets out the payment requirements can prevent this. However, it is available to you.
Why should you have a contract with your clients?
It’s always a good idea to have something in writing, no matter how great your relationship with your clients. Why?
The sooner you do this, the fewer headaches, misunderstandings, and expenses you will have later on.
It will be a good idea to have the following features in your contract with your clients:
- Have all the key terms and conditions – Your agreement should describe what the key actions items are
- Finalise the revenue streams – Detail how you would like to receive your payment, e.g. whether you want it in instalments or require any deposits
- Limit your liability – Include any clauses that will limit your liability if something goes wrong
- Intellectual property clauses – Materials created by clients and employees belong to you
- Plans for dispute and resolution – If there are any mishaps down the track, outline how to resolve this
Putting all your requirements in writing will ensure both you and your client are on the same page at the beginning of the working relationship.
As a sole trader, should you sub-contract your work?
If you decide to work as a sole trader, there may be a time that you want to sub-contract some of your work to another business.
For example, let’s say that you’re a photographer and you own a photography business.
As a photographer, you might offer general photography services. However, some of your clients might ask for more specialised work on top of your general tasks. For example, a photoshopping task.
So, what happens if you can’t offer this photoshopping requirement, but you don’t want to lose your client?
You can subcontract out some of your work to someone who specialises in photoshop in this situation. Your client will pay you for it, and then you will pay the contractor who has provided you with the photoshop services for you.
It’s pretty awesome, isn’t it? However, there are some risks with sub-contracting.
For example, your client needs to be happy for you to sub-contract some of your work. They may not be okay with this, so it’s essential to double-check from the very beginning.
Another important thing to be mindful of is if you promise your client one thing, you need to make sure that your sub-contractor is across the same thing.
The best way to ensure that this happens is by having a sub-contractor agreement with the sub-contractors that you find to outline:
- What tasks are to be completed
- How you will pay the sub-contractor
- What happens if the client is unhappy with the work
Having a lawyer can help you ensure that your sub-contractor’s agreement covers everything you require for a smooth relationship.
What happens if my business grows?
If you choose to set up as a sole trader, there’s a genuine possibility that your business can grow, and you may start thinking about setting up a more formal structure.
If this happens, you can change your business structure and choose to have a partnership or a company. Let’s go through the differences between them.
A partnership combines the resources and expertise of many people. The profits and losses are shared amongst the partners, and any profits do not need to be disclosed to the public.
A company is a separate legal entity, and its shareholders are not liable for its debts. A company can trade anywhere in Australia and has a lower tax rate than the highest tax bracket for individuals.
While there is no requirement for you to change your business structure, it’s still a good idea to be aware of the different options available to you if you plan to change your structure.
If you want to learn more about the different business structures out there, read our latest blog.
Frequently asked questions (FAQs)
Let’s go through some frequently asked questions that you might receive operating as a sole trader.
Do I need an Australian Business Number (ABN) as a sole trader?
The short answer is no. Unlike a partnership, company or trust, there is no legal requirement to register for an ABN as a sole trader.
However, there are benefits of having an ABN as your business’s income and complexity increase. For example, registering for an ABN allows you to:
How much tax should I put away as a sole trader to pay tax bills?
With an ABN, tax is not taken directly from the source. For example, a carpenter raising an invoice will receive full payment for their work. There will be no tax deductions at this stage.
Operating as a sole trader with an ABN, you need to set aside a portion of your income to meet your tax obligations when the financial year ends.
When June rolls around, you must include your ABN earnings with any other income received; tax is assessed based on that combined income after you lodge your tax return. The tax-free threshold sits at $18,200. If your income is higher than this, then progressive tax rates will apply.
Whether you’re still deciding to operate as a sole trader or you’ve just begun your entrepreneurial journey, there is a lot to think about.
If you want to keep things simple, a sole trader structure is a way for you.
However, if your business starts to grow, you always have the option of changing the type of business and business structure that best meets your needs. You could choose to have a partnership or a company.
If you want some assistance setting up your sole tradership why not hire a Lawpath lawyer to help you get started.