As a sole-trader you are operating your business as an individual and are personally responsible for its operations. Any profits you generate from your business will be taxed as part of your individual tax return. How this is determined has been outlined below.
Trading as an individual means that sole-traders are taxed at their marginal tax rates. The income that sole-traders are taxed on is the aggregation of their business profits and any other income derived at the individual level such as investment income (eg. interest or dividend income), employment income, or capital gains on the sale of an asset.
Each individual taxpayer has access to a tax-free threshold which is currently $18,200. This means that for the first $18,200 you earn through your sole-trader activity and other income sources you will not pay tax on. Income earned over this threshold will be taxable, the amount of tax payable being determined subject to the total amount of income derived by the individual. The rate of tax that is applied to each threshold for the 2023 financial year is summarized below.
Resident Tax Rates 2022-23
|Taxable Income||Tax on this income|
|0 – $18,200||Nil|
|$18,201 – $45,000||19 cents for each $1 over $18,200|
|$45,001 – $120,000||$5,092 plus 32.5 cents for each $1 over $45,000|
|$120,001 – $180,000||$29,467 plus 37 cents for $1 over $120,000|
|$180,001 and over||$51,667 plus 45 cents for each $1 over $180,000|
The above rates do not include the Medicare levy of 2%.
What income from your sole-trader business do you pay tax on?
As a sole-trader you pay tax on the profit you have made. Your profit is the sum of the business income you generate less any business related deductions.
Where you have more than one sole-trader business in an income year you combine all of your activities to come up with a total business profit.
If your business deductions exceed the income derived, your business has made a loss and this loss will either be carried forward to the following year to be recouped from business profits or in some circumstances, subject to eligibility, offset against other income you have derived as an individual in the financial year. Once you have determined your business profit, this profit is aggregated with your other income to determine your total taxable income. It is your total taxable income that your tax liability will be calculated upon.
Once you have determined your business profit, this profit is aggregated with your other income to determine your total taxable income. It is your total taxable income that your tax liability will be calculated upon.
Calculating Tax for Sole-Traders Example – Part 1
Joe is a sole-trader operating a plumbing business. For the 2022 financial year Joe generated $140,000 in sales and incurred $84,000 in expenses. This left Joe with a total business profit of $56,000.
In addition to the plumbing business profit, Joe received $5,000 in bank interest and made a capital gain of $3,000 on a quick buy/sell of crypto currency during the financial year.
Based on this activity Joe’s total taxable income is $64,000. This level of income puts Joe in the $45,001 – $120,000 tax bracket. Tax payable by Joe on his income is determined as follows:
The first $18,200 of Joe’s income is tax free;
The next $26,800 is taxed at 19% – $5,092
The remaining $19,000 is taxed at 32.5% – $6,175
In applying the marginal tax rates to Joe’s taxable income, the tax payable by Joe is $11,267 excluding the 2% medicare levy. This is an average tax rate of 17.6%.
Small Business Income Tax Offset
Sole-traders may be eligible to apply the small business income tax offset to reduce the tax payable on their business income.
To be eligible you must be carrying on a business as a sole-trader and the business must have an aggregated turnover of $5 million or less.
The offset is worked out based on the proportion of tax payable relating to your total net small business income. The maximum offset that can be applied is $1,000.
To work out your small business income tax offset you use the following formula:
Calculating Tax for Sole-Traders Example – Part 2
Joe is eligible to apply this offset as he is carrying on a business and his turnover is less than $5 million.
To calculate the offset Joe must first work out the percentage of income that comes from his net small business income:
Joe’s small business income for the year (ie. profit) is $56,000
Joe’s total taxable income for the year is $64,000
$56,000/$64,000 = 87.5%
87.5% of Joes’ income is from his small business activities.
Next Joe must calculate how much of his tax liability comes from his total small business income. This is determined by multiplying the percentage of income relating to the small business income (87.5%) with Joes’ total tax liability ($11,267).
$11,267 x 87.5% = $9,858
This means that $9,858 of Joe’s tax liability relates to his business profits.
Lastly, to determine the actual offset, Joe must multiply the tax liability relating to the business profits with the small business tax offset rate (16% as set by the ATO for the 2022 year).
$9,858 x 16% = $1,577
The small business tax offset is capped at $1,000 and given Joe’s liability is greater than this, at $1,577, Joe can apply the full $1,000 offset to reduce his 2022 tax liability.
On this basis, Joe’s tax liability after applying the offset will be $10,267 ($11,267 – $1,000).
It is important to note that the small business income tax offset is not refundable. Further, it should be noted that where your net small business income is a loss, for the purposes of the offset it is treated as 0 and you will not be entitled to any offset.
How do you pay tax as a sole trader?
A sole-trader’s tax liability is determined through preparation and lodgment of an annual income tax return. A notice of assessment will be issued upon lodgment of the return and tax will be payable on this assessment.
To assist with managing tax payments over the year and not incurring large lump sum liabilities on lodgment of the tax return, most sole-trader’s will pay tax quarterly as part of the Pay As You Go regime (PAYG). Under this regime tax instalments will be paid quarterly that will go towards the total tax liability that will be paid in a financial year. The annual tax return lodgment will then see a balance payable on any shortfall or a refund if more tax has been paid than is required.
The quarterly system can help with managing cash flow, a critical component of maintaining a profitable business.
How can we help?
As your accountant we can help you manage your taxation obligations, ensuring we maximise your after tax dollars through planning, guidance and application of various offsets and concessions. Leaning on us to take care of the numbers and compliance obligations will leave you focus on what is important – your business.
Below are some links to calculators published by the Australian Taxation Office (ATO) you may find useful in estimating your tax liability and small business income tax offset:
For more information regarding the pros and cons of operating as a sole-trader and whether it is the right structure for you, read our article ‘Sole Trader – Is it for you?‘. Alternatively, if you would more guidance, please contact us directly on 03 5221 6399 or at email@example.com.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article
This article was written by Tax and Business Services Director Kylie McEwan.