• What exactly does a sole trader have to do to ensure they're tax compliant?
• From GST, PAYG, calculating income tax and record keeping, it can seem overwhelming trying to figure how how to do your taxes properly.
• In this guide, we go back to basics and break down the key tax requirements for sole traders to make the process less stressful.

In my role as a tax accountant, I get numerous requests from sole traders and small business owners to help them to complete their individual tax returns, as well as their business returns.

It seems to be a common misconception that sole traders need to do two tax returns, which is incorrect.

So what does a sole trader need to do tax-wise in order to be compliant?

If you’re not up to speed with the latest laws and requirements, filing your annual return can be a little unnerving. What paperwork do I have to complete? Which rules apply to me? These are just a couple of the many questions soler traders have about tax.

Well, let’s go back to basics.

What Is the Definition of a Sole Trader?

A sole trader is the simplest type of business structure and is relatively easy and inexpensive to set up.  All you need to do is register an ABN (Australian Business Number). It's free to apply online for an ABN with the Australian Business Register.

If you use your own name e.g., Joe Bloggs, you do not even need to register a business name. However, if you want to trade as Joe’s Bicycle Repairs, then you will need to register a business name. This is done through the Australian Securities and Investments Commission (ASIC).

As a sole trader, you are legally responsible for all aspects of the business, and you retain complete control of your assets and business decisions. All revenue and expenses are taken up by the one person operating the business. 

It’s generally easy to change your business structure if your business grows, or wind up the business if you need to.  

However, under a sole trader structure there is no legal separation between the owner and their business which means that the owner is responsible for all the liabilities of the business. Their personal assets are not protected from creditors in the event of the business failing or if there is a relationship breakdown. There are also limited tax planning opportunities - you are personally liable for the tax on all the taxable income from the business.

So, what are the tax requirements for a sole trader, and how does it work?

What Are the Tax Requirements for Sole Traders?

When you are working full time for an employer, your tax return is relatively simple - you use the income statement generated by your employer to file taxes once a year (this used to be called a payment summary or group certificate).

As a sole trader, you won’t have these payment summary/income statements for the business you run.  Instead, you need to maintain your own accounting records to determine the income and expenses and ultimate taxable income of the business.

Here's a handy tip: Accounting software with bank feeds is the simplest way to streamline the record-keeping process, especially if you are registered for GST and/or employ staff. A separate bank account for business transactions is critical as a minimum.

Basic Tax Requirements for Sole Traders 

Below are some basic concepts you should understand when it comes to sole trader tax:

1. Calculating your income tax (including what expenses you are able to deduct from your taxable income)
2. Making PAYG instalments
3. Understanding Goods and Services Tax (GST) - and if you need to be registered, including lodging your Business Activity Statement (BAS)
4. Important tax deadlines and record keeping

Let’s take a look at some of these topics more closely.

1. Calculating Your Income Tax

There are far fewer reporting requirements for sole traders, and you use your own individual tax file number (TFN) to lodge tax returns.

Any income that you earn is reflected on the same tax return. If you are employed and have salary and wages income, this is shown in one section of the income tax return.

Income earned and expenses incurred from the trading activities on your ABN are reflected on a business schedule in the same tax return (included in a different section on the income tax return).

In the most basic sense, your taxable income is the amount of money you make from your goods and services in a financial year (not including GST if you are registered), minus your business expenses (excluding any GST claimed).

For example, if you earn $150,000 and have business expenses totaling $32,600, your taxable profit from the business will be $117,400.

This business profit is then added to the employment income and any investment income i.e., interest or dividends or rental income and the total taxable income determined. Business losses can be offset against employment income unless it is a non-commercial loss - in which case, it is deferred and offset against future income.

Taxes are then calculated per the tax tables i.e., the same rates as employed individuals. Sole traders get a small business tax offset (maximum of $1,000) in addition to the other available offsets (like low middle-income tax offset).

You can calculate your tax rate by using the current tax tables provided by the Australian Tax Office (ATO).

What Expenses Can I Claim to Reduce My Taxes?

Below are some of the common business expenses sole traders can claim:

• Valid business expenses, such as advertising, accounting fees, subscriptions, stationery and postage, uniforms or PPE, bank and merchant fees, legal fees (not capital in nature) - to name a few
• Phone and internet bills (apportioned for business use)
• Home Office equipment - like computers, printers, phones, desks and chairs and other office furniture
• Home office expenses (if your home serves as a base for your business) - includes running expenses and occupancy expenses which would need to be apportioned for the area used for the business. There is the option to use cents per KM to claim on a per hour basis
• Rent expenses for any commercial office space
• Home repairs or maintenance (if you conduct business within your home) and repairs to any business equipment       
• Bank fees, and interest on your accounts
• Business travel expenses
• Training, education, and professional membership fees
• Insurance
• Depreciation on assets purchased
• Motor vehicle expenses
• Either cents per KM (set rate per business KM you travel, limited to 5,000km per car per year) or
• Logbook method (business use % of actual expenses like fuel, repairs, insurance, rego, lease payments, insurance, depreciation, interest on finance).
• Other deductions include tax agent fees, donations, and income protection premiums.

The above list is not meant to be exhaustive and needs to be considered in light of what it is that you do as a business - as some expenses will be deductible in one type of business but it could be a private expense in another type of business.

For example, a cake maker will be able to deduct eggs, milk, butter, flour and other ingredients to produce the cakes, but these expenses would not be deductible for a mechanic, as they are not related to the business.

So, the golden rule: You need to have incurred the expense in order to produce income, and it can’t be of a private nature (like childcare). You are also only able to claim an expense to the extent that it has been used for business purposes, which means that you may need to apportion the expense e.g., your mobile phone. If your monthly mobile phone contract is $60 and you use it 60% for business - then only $36 is deductible.

Another important thing to remember - the tax that you are saving is only the effective tax rate, not the full expense amount. So, if you buy a printer for $200 and the effective tax rate you are paying is 23% - you are only saving $46 in tax – so don’t go and spend for the sake of it – as it's eating into your profits.

When considering making a purchase as a way to reduce tax, make sure you weigh up whether or not it’s actually needed, and whether the business can afford it too.

When considering your tax planning strategies,  don’t forget about Super! Making contributions to your super is both a tax deduction and grows your retirement savings. Sole traders can claim up to $25,000 of their super contributions as a tax deduction. There are some catch-up contribution rules in place currently (a notice of intention form needs to be completed and submitted to the Superfund and a letter of acknowledgment received back).

You can read more about each deduction on the ATO website, or find a tax agent to help you navigate this.

2. Making PAYG Instalments

In the first year that you have an ABN - you would not have paid any taxes on the business income derived, so would likely have a tax debt.

This then triggers the (Pay as You Go) PAYG instalments system to be activated. You start paying PAYG instalments towards the following year's estimated tax debts. This means you are paying your income tax quarterly in advance i.e., a prepayment of your tax for the following financial year. The amounts paid are then reflected as credits against the tax due on assessment. Any overpayments will be refunded on assessment.

You have two options when it comes to paying your PAYG instalments:

1. A predetermined instalment amount: This figure is set by the ATO with reference to the assessed tax on your latest tax return. If you think you will make a similar amount in the current tax year as you did in the previous tax year, then you can use this option.
2. You can set your own instalment rate using the rate suggested by the ATO or you can estimate your own instalment rate: This is a good option if you expect your taxable income to be considerably different this year than last year, or if your income fluctuates seasonally.

You can manage all of your PAYG instalments through the myGov website. Depending on your settings, you should get reminders when the instalments are due for lodgement and payment.

For 2020-2022, the PAYG due dates are:

• July 28 - Q4 (income earned April - June)
• October 21 - Annual PAYG instalment date
• February 28 - Q2 (income earned October - December) (the actual due date is 2 March in 2022)
• April 28 - Q3 (income earned January - March)

3. Understanding Goods and Services Tax (GST)

You will need to register your business for goods and services tax (GST) if your annual turnover is expected to be more than $75,000.

You will then be required to charge GST on your sales (some may be zero rate depending on what it is you are doing) and will then be able to claim any GST paid. Just remember that the GST credits can be claimed for the amount of the GST, but the balance of the expense can be claimed as a tax-deductible purchase if it’s made for the business.

Once registered for GST, you are required to lodge Business Activity Statements (usually quarterly with the same due dates at the PAYG instalments) and would be declaring your quarterly sales, GST on those sales, GST on expenses and the net amount due or refundable (Simpler BAS).  Your PAYG instalment is reflected in the same form.

Employment Taxes

You are not considered an employee of your own business - so you don’t pay payroll tax or superannuation or workers compensation on any income you draw from the business.

You can employ employees to assist you in your business - which means you would register as an employer. You would then be responsible for the pay-as-you-go withheld (PAYGW), Super and workers compensation.

PAYGW is declared and paid to the ATO generally on a quarterly basis on the BAS activity statement, or monthly on an IAS activity statement.

Just remember - as a sole trader you can't claim deductions for money that is drawn from the business. Money taken from the business is not wages for tax purposes i.e., they are not tax-deductible. You are effectively drawing the profits of the business (that have not yet been taxed).

4. Important Tax Deadlines and Record-Keeping

For a business expense to be deductible, the ATO requires that three criteria be met. In addition to the two mentioned above in the golden rule, you must have records to prove the expense.

The ATO does say that electronic copies of your receipts are fine, so feel free to take screenshots or photos of your receipts and upload them to your accounting software or a secure storage system, or to the ATO app (not submitted to the ATO, unless you do this).

Bank statements or EFTPOS receipts are not enough. You also need to ensure that the receipt is legible and specifies what was purchased. Be careful that the receipts don’t fade - so photocopies or scanned copies are good.

Note that having a ‘record’ does not always mean you need a receipt - for example, it could be a diary entry of the number of washes you do to claim your laundry.

To keep track of these expenses, make sure you are regularly updating your software or Google or Excel sheet. This allows you to keep on top of your numbers throughout the year as well as maximise tax deductions as you will not forget to claim something. Don't forget to record your vehicle mileage too – there are many apps available that do this (including the ATO app).

Summary

So, now you know what you need to do to survive taxes as a sole trader. By the time tax season comes you will be ready to maximise your tax return, be prepared for any tax debts (through your PAYG instalments) and be ready to focus on growing your business further.