Being a sole trader means you and your business are one, especially when it comes to finances (you don’t even need a separate business bank account).
Unlike an incorporated company, where profits belong to the company itself and not the individual, all the money your business earns technically belongs to you. So you’re not exactly paying yourself as much as withdrawing money from your bank account that’s already yours.
But you are also running a business. Because of this, a portion of it may need to be set aside for expenses, overheads, supplies. Plus, you’ll have your individual income tax to pay to the ATO. So in reality, while the money is in your account and under your name, you may not be able to splash some cash and spend freely. Because of this, keeping track of your cash flow is crucial to ensure you cover all costs.
Make sense? To begin with, let’s look at how “paying yourself” as a sole trader is different from earning money through a company.
- Paying yourself through a company
- Earning as a sole trader
- Keeping on top of your cash flow
- How Hnry helps
Incorporated companies
If you’re running an incorporated company (known as a Pty Ltd), the profits belong to the business, not you directly. To take money out of your business, you’d likely use one of four common methods:
1. Salary
To pay yourself a salary, you’d first need to become an employee of your own company.
This means notifying the ATO, paying PAYG tax, issuing yourself an end-of-year PAYG Payment Summary (known as an income statement), and making compulsory superannuation contributions, all of which involves a fair bit of time and paperwork.
Your salary would be considered a business expense, so it can reduce your business’s tax liability, but may not be the most tax-efficient as your salary grows.
2. Dividends
Dividends are payments made to shareholders from a business’s after-tax profits (not income). You don’t have to pay super on dividends, but you do have to pay tax on them at the end of the financial year as they form part of your taxable income.
As a company shareholder, you can receive two types of dividends: “franked” and “unfranked”.
Franked dividends are like a pre-paid gift. The company has already paid some tax on these profits before distributing them to you. This means when you declare these dividends on your tax return, you get a credit for the tax already paid by the company. Essentially, you don’t have to pay tax twice on this money (nice, right?).
An unfranked dividend is like a franked dividend – however no tax has been paid on the profits before being distributed to you. This means that there’s no tax credits associated with that income. So in your personal tax return, you’ll pay all the tax on these dividends at your personal effective tax rate, just as you would with any other income, as there’s been no tax already paid or withheld on your behalf.
There are even partially franked dividends whereby only a portion of the dividend has been taxed at the company rate.
You’ll also need to remember that by paying yourself dividends instead of a salary, your company’s profits will appear larger because dividends aren’t tax-deductible like wages are. This means the company may end up paying more in company tax since it doesn’t get the tax break that salary payments provide (ouch!).
As you can see, paying dividends can be complicated! Plus if you go down this route, it’s a good idea to get help from an accountant and/or financial advisor to make sure you stay compliant – which may be an extra expense for you to pay.
3. Mix of wages and dividends
You could choose to take a minimal salary as well as dividend payments to maximise your tax benefits. But trying to figure all this out on your own is tricky (and the fee you’d need to pay a financial expert could wipe out any tax benefits you may gain).
4. Director’s loan
Also known as ‘drawings’ or a Div 7A loan, this allows you to take money out of the company without PAYG tax and superannuation obligations. But, you have to draw up a loan agreement, pay interest, and pay back the loan, as well as other tax considerations
So while there are some benefits to having an incorporated company if you need one, it doesn’t automatically equate to tax benefits. As a director of an incorporated business, your salary will be taxed at your personal tax rate. Additionally, the company itself needs to pay taxes on its profits, with the corporate tax rate set at 25% from 2024 onwards. Plus, you’ve got the extra lodgement requirements and costs that come with setting up and running a company. So any tax you may save may be eaten up elsewhere.
As you can see, earning through an incorporated company is way more complicated than being a sole trader and just doing your own taxes (or letting Hnry do it for you).
Sole traders
How to “pay yourself” as a sole trader
Life as a sole trader is more straightforward (hooray!). You “pay yourself” by accessing the funds in your account however you please. No complicated payroll setups here.
But these withdrawals are not tax-deductible wages. All income that you make in your business is yours to spend, but also yours to pay tax on.
Can you pay yourself a wage as a sole trader?
There’s technically no such thing as “sole trader wages”. All the money you earn through your business is also your personal income.
How to pay tax as a sole trader
To pay your sole trader taxes, you’ll need to lodge a personal tax return at the end of the financial year, reporting all your income from all income sources – including your sole trader business.
You may also opt into Pay as You Go (PAYG) installments voluntarily, which allows you to prepay tax on your sole trader income throughout the year. By doing so, you can dodge a hefty tax bill when you lodge your tax return at the end of the financial year.
Alternatively, you could just use Hnry – we do it all for you.
Keep on top of your cash flow
Because it’s so easy to access your money as a sole trader, it’s a good idea to stay on top of your cashflow to make sure you meet your tax obligations as well as other important payments. Just because your bank balance looks healthy doesn’t mean it’s a good idea to splurge on that gold-plated coffee machine or a year’s supply of gourmet donuts!
Here’s a few ideas around how to keep things in check:
Understand exactly what’s yours to spend
Remember to only spend your business’s profits, not net income. Don’t spend what you need to use to keep making your products, servicing your clients, or paying your bills!
📖 Check out Hnry’s guide on how to measure and grow your sole trader business profit.
Separate business and personal finances
You can open a separate business bank account and keep detailed records of all your income and expenses. This helps you keep track of how much you’re making and what you need to set aside for business expenses and tax.
Track all your expenses
Keeping good records of all your business expenses, including cost of goods sold, overheads, rent, employees, insurance, advertising and marketing costs and so on – and claim them as tax deductions.
Don’t forget these important payments:
- Income tax: Your first $18,200 is tax-free (yay!). After that, your effective tax rate will depend on your income bracket.
- GST (if applicable): If you make $75,000 or more in business income, you’re required to register for and charge GST (as of 2024 this remains at 10%). If you pay more GST on goods and services you buy for your business than the GST you’ve collected, you may get a GST refund.
- Medicare levy: A mandatory fee every working Australian (with some exceptions), pays to the government to help fund the public health system.
- Student loan repayments (if applicable): If you earn above the repayment threshold ($54,435 for financial year 2024/25), you’re required to pay a set percentage of every dollar you earn towards your student loan debt.
- Superannuation contributions: Do you have to pay yourself super as a sole trader? While you’re not required to pay super as a sole trader, it’s a smart move to think about your future (hello beach house retirement!) and potential tax benefits. We’re often asked ‘How much super should I pay myself as a sole trader?’ Since employers pay 11.5% currently, that’s a good guide, but be sure to check out any limits and speak to a financial advisor.
By the way, Hnry can help with taxes
We’re probably biased, but we really believe that the best way to sort your taxes is by using Hnry.
Hnry pays your taxes throughout the year, so you’ll never have to think about tax again.
If the amount you earn fluctuates from month to month, Hnry automatically adjusts your income tax rate as you go to ensure that you pay the exact right amount of all your taxes – whenever you get paid.
That means:
- No more under or over-paying your Income Tax.
- No more worrying about your other taxes like GST, or your Medicare Levy – Hnry takes care of all your taxes for you, and lodges all your returns on your behalf.
- No need to pay for a separate accountant and multiple software tools to handle your financial admin – Hnry is an all-in-one service.
Our team of accountants and tax experts, and our award-winning software, have got your back.
Join Hnry today!
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