Which business structure is best?

Choosing whether to operate as a sole trader, company, partnership or trust depends on many factors including cost, the size of the business, whether you have dependants and family members to share income with, and the degree of financial or legal risk involved in running the business.

Sole trader

Many small operators start out as a sole trader, and some decide to continue with this structure.

On the positive side, it’s easy to set it up and, with fewer business reporting obligations, it’s cheaper to run than other business structures.

There are one or two considerations that, depending on your circumstances, could mean a sole trader structure doesn’t work for you.

One of these is the extent of your liability if things go wrong. When you’re a sole trader your liability is unlimited, meaning your assets are at risk in the case of legal action. Some businesses may consider their risk to be too low to warrant changing the business structure or they may choose to find an insurance product to provide some protection.

Tax is another consideration. Among other issues, as a sole trader, you’re liable to pay tax on all income received by the business and you can’t split profits or losses with family members.ⁱ

Partnership

Two or more people can form a business partnership and distribute business income among themselves.

Like a sole trader structure, a partnership structure can be slightly cheaper to operate because there are minimal reporting requirements.

All partners are liable for all the debts and obligations of the business although there are different types of partnerships that vary liability among the partners.

For tax purposes, each partner reports their share of the partnership income or loss in their own return and pays tax on any income. Partners cannot claim a deduction for any money they withdraw from the business. Amounts taken from a partnership are not considered wages for tax purposes.ⁱⁱ

Company

A company structure has a number of advantages over a sole trader or partnership structure, but it costs more to set up and operate and there are more reporting requirements.

A company is considered a separate legal entity and has its own tax and superannuation obligations, but company directors have a number of legal responsibilities.

Companies pay an annual fee to be registered with the Australian Securities and Investments Commission (ASIC) and they usually cost more to put together the necessary annual accounts and tax return.

On the plus side, you will be able to employ yourself and claim a tax deduction for your wages.

But be aware of the Personal Services Income (PSI) rules. If more than 50 per cent of the income of the business is produced by your personal exertion, it’s considered PSI and you will pay tax at your marginal rate, rather than the lower company tax rate. This rule affects taxpayers with any business structure.

Trust

A trust is the most expensive and complex business structure to operate but it might be the most appropriate for your needs.

There are some pluses and minuses so expert advice from your accountant and lawyer is crucial. You will need help to decide on the type of trust, to set up a formal trust deed and to carry out annual administrative tasks.

On the positive side, there may be tax advantages and there are some protections from financial and legal liability.

On the flip side, all income earned must be distributed to beneficiaries each year otherwise tax is paid at the highest marginal rate. Also, losses can’t be distributed to beneficiaries, it may be difficult to dissolve or change elements of a trust and it may be more difficult to borrow funds.

Ask for guidance

The importance of choosing the best business structure for your needs and understanding the regulatory requirements is crucial to the success of any small business. Check in with us for expert guidance.



i Sole trader | business.gov.au
ii Business structures - key tax obligations | Australian Taxation Office (ato.gov.au)