Self Employed and Sole Trader

The terms “sole trader” and “self employed” are often used interchangeably. They generally refer to someone who’s “doing their own thing”. Technically, there isn’t much of a difference between the two with regards to their respective day-to-day roles.

However, the term self employed is generally used to describe someone who’s not working for an employer and is therefore not subject to Pay As You Go (PAYG) tax. The term sole trader, on the other hand, is used to describe your business structure in terms of who would be responsible for the business’ profits, losses, and liability – legal or otherwise.

So, if you think about it, the two terms generally refer to the same activity but different entities. Self employed refers to the individual; Sole trader refers to the business structure.

Now that that’s out of the way, what is the difference between self employed and sole trader with regards tax, debt liability, and insurance obligations? This article explores everything you need to know about them.

Tax for Sole Traders

One of the key differences between sole traders and self employed individuals has to do with filing tax returns. If you don’t meet the requirements for filing a company tax return and earn income as the sole owner of your business, then you are required by law to file what is known as a sole trader tax return.

There are generally two different types of taxes you need to be concerned about when filing a return or lodging an application for a tax refund.

  • Goods and Services Tax (GST)
  • Income Tax

Most of the goods and services sold in the country are subject to 10% GST. As a sole trader in Australia, you’re required to register for GST if your business’s annual turnover exceeds $75,000. To do this, you have to complete and file a Business Activity Statement (BAS) every quarter, and submit it to the Australian Tax Office (ATO).

You’re also required to put aside money to pay the income tax due at the end of the financial year. This is usually done in quarterly PAYG instalments. Sole traders are subject to the same tax rates on income as individual taxpayers.

Personal Services Income as a Sole Trader

Now, if your income as a sole trader is derived mostly (50% of it, at least) from your skills, expertise, or personal efforts, your revenue is categorized as personal services income (PSI). You’ll need to report this when lodging your return.

Common examples of professions that receive PSI include engineers, medical practitioners, IT professionals, and financial consultants.

Tax as a Self Employed Individual

To reiterate, being self employed means that you don’t work for an employer, so you’re not subject to PAYG tax. Sole trader refers to the business structure and not the individual per se.

So, while you can be self employed, it doesn’t necessarily mean that you’re a sole trader. You can be self employed while in a partnership. You can be self employed as an independent contractor. You can even be self employed and run your business in a company structure.

So, as you can see, being self employed has nothing to do with the business structure (or lack thereof) that you operate in. This brings us to the question – What taxes do you need to pay when you’re self employed?

Well, it all depends on your business structure since being “self employed” isn’t a structure in itself. If you’re a sole trader, then your earnings fall under personal income, which is subject to income tax. You’ll also need to register for and pay GST.

If you’re self employed, but running your business under a company structure, it is subject to company tax, which currently stands at 27.5% if the annual turnover is less than $50 million.

Anything above that and you graduate to the 30% company tax bracket. Companies are also subject to GST.

Capital Gains Tax for Self employed Individuals vs. Sole Traders

One key difference in taxation is evident in how capital gains tax is treated. If you’re a sole trader who’s owned an asset for at least 12 months, you qualify for a 50% discount on your capital gains tax. This also applies to self employed individuals who operate as sole traders.

On the flip side, if you’re a self employed person running your enterprise as a company, you don’t get to benefit from this discount. But, on the plus side, you are entitled to certain concessions if your company is a small business.

What Is the Difference Between Self Employed and Sole Trader in Terms of Business Debt Liability

Once again, it all boils down to the business structure. If you’re self employed operating as a sole trader, you are individually liable for any tax or financial debt your business incurs.

The structure of a sole trader does not set out any clear division between what constitutes business vs. personal assets. So, any personal assets you have in your name can be used to settle debts incurred by your business.

On the other hand, if you’re self employed and running your enterprise as a company, you as an individual cannot be held liable for any debt your business incurs. A company is a legal entity that can own assets, sue, and be sued.

Nonetheless, you could potentially face a certain level of risk if you’re listed as director and the company is unable to pay its debts. Your assets may be sold to help settle these debts. So, it’s not set in stone.

Insurance for Self Employed Individuals vs. Sole Traders

Whether you’re self employed running a sole trader or self employed running a company, the business activities you engage in will determine the type of insurance you’ll need.

If you employ people, you should consider getting insurance coverage for personal injury, death, disability, and workers’ compensation. Keep in mind, however, that if you’re a one-man-show, you may not be eligible for a workers’ compensation cover. You can get the rest, though.

As a director in your company, you may also need to get directors’ liability insurance, although it is not compulsory.

Choose the Right Structure for Your Business

The bottom line – What is the difference between self employed and sole trader? Not much.

Being self employed, however, means that you’re not working for an employer and are therefore not subject to PAYG tax. It has nothing to do with the structure of the business you’re running, which means that you can be self employed while running a sole trade, a partnership, or a company. A sole trader is simply the business structure adopted.

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