How To Determine The Best Business Structure For You

Starting a business? Many people slip from being employed into being an independent contractor, keeping it unofficial until the concept gains traction and there’s scope for a legitimate business to take shape. At this point, you can start looking at the direction you’d like to take. Would you like to see your one-man band become a team of capable professionals? Are you keen to share the risks and responsibilities with another trusted ally? Or do you want to be an independent professional? Here is a summary of the common business structures and how they can work for your business goals.

Sole trader

A sole trading structure is for you if…

you are unsure of your business concept or unsure if your activity is going to be a business or a hobby. If business risks are high then this is not the structure for you.

A sole trader is a business that is owned and operated by a single individual; a sole proprietor. In legal terms, the business and the individual are not considered separate entities. The individual is responsible for any debts and liabilities incurred by the business. If your business goes into debt, your personal assets can be at risk. In this case, personal income and business income and expenses will be filed on the same tax return. Any business losses can be offset against other income, provided certain conditions are met.

Partnerships

A partnership is for you if…

you want to keep your business structure simple, and the taxable income of the individual partners are taxed at marginal rates less than the company tax rate. Again, if business risks are high then this structure is not for you.

This can be an option for two or more individuals or entities that want to go into business with each other as co-owners. This means they share the profits and accept equal responsibility for the debts and liabilities of the business. It is imperative to have a clear and detailed partnership agreement in place. A partnership files a tax return separate to its owners. The owners then include their share of the partnership income or loss (provided certain conditions are met) in their personal returns.

A company

A company is for you if…

you are serious about growing your business and protecting your assets. You will also need to be happy to take on the additional compliance burden.

A company is a separate legal entity to that of its owners (a private company can have up to 50 shareholders), resulting in any liabilities being limited to the company. Companies are taxed at a flat rate, currently, 26% provided the company is trading and has a turnover of less than $50m and reducing to 25% from 1 July 2021 onwards. Trading your business through a company comes with more responsibility and paperwork than that of a sole trader or partnership. Failure to meet some of your responsibilities can result in you being personally liable for example if you fail to pay PAYG withholding on employee wages, fail to pay employee’s superannuation or trade while insolvent. Our eBook Now I have a company, what do I need to know? and our blog Can I DIY my company set up, to save myself some money? are two handy resources if you are considering trading through a company structure.

Trust: Discretionary Trust

A discretionary trust is...

a great option for families who are wanting to split income, protect assets and grow wealth. Discretionary trusts do not work where people are unrelated as there is no fixed entitlement to income. A business can be traded from a discretionary trust, however, they are most effectively used as an investment vehicle and can own the shares in the company where your business trades. You also need to be happy to take on the additional compliance burden.

A discretionary trust offers flexibility in the distribution of profit to trust beneficiaries who are then taxed at their marginal tax rate, and if a company then taxed at the company rate. With a company acting as a trustee, trust also has the benefit of limited liability. Losses cannot be distributed to beneficiaries and can only be offset against future income provided that a number of requirements are met. Also, all income in a trust must be distributed otherwise it attracts tax at the highest marginal tax rate. This means that there is a real possibility that funds reinvested in the business may have been taxed at a higher rate than the company tax rate. A company may be a more tax-effective way to grow a business. If you want to combine the benefits of both companies and trust then our How to give your business the benefits of both companies and trusts is for you.

Trust: Unit Trust

A unit trust is for you if…

you find yourself in situations where the parties are not related and yet want the features of a discretionary trust but a fixed entitlement to income like a company. A unit trust provides a fixed entitlement to income for each of the unitholders and again with a company as trustee offers limited liability. Like a discretionary trust, all income is distributed at the end of the financial year and losses can’t be distributed to the beneficiaries.

A word of caution

If you receive personal services income (see our blog: What is personal services income and do I earn any?) or conduct a personal services business (see our blog: What is a personal services business and is my business one?) there are additional rules that apply. These rules may impact what you can claim as a tax deduction and how your income is taxed regardless of what structure you choose to trade from. Furthermore, each business is different as are the goals of the business owner, so it is important that you seek the advice of your accountant before deciding which structure or combination of structures is right for you.

If you would like specific advice tailored to your business and circumstances, Accounting Heart offers affordable service packages where you can work with Sonia one-on-one to help you get your business where you want it to be. Book your FREE Discovery Call to find out more.

Disclaimer: This is general information only and is not advice of any sort. No warranty or representation is provided by Accounting Heart Pty Ltd as to the accuracy, currency or completeness of the information contained in this blog. Readers of this blog should not act or refrain from acting in reliance upon any information contained herein and must always obtain appropriate taxation and / or other advice as may be appropriate having regard to their particular circumstances.