When launching a new business, it is first necessary that you understand the business structures available to you. This enables you to choose the best business structure that manages your risks, protects your assets, limits your liability, manages your tax obligations and gives you a strong platform for future growth.
In this business structures series, our articles focus on the various structures through which you can run a business. Namely, a sole trader, partnership, company and trust. Our last article looked at the advantages of running a business as a sole trader, and we now turn to looking at the disadvantages.
What is a Sole Trader?
As previously discussed, a sole trader is an individual trading on their own. Their business revenue is treated as personal income, and the individual is personally liable for all aspects of the business (and accordingly, their personal assets are at risk). We do not recommend this structure if you intend to grow your business.
What are the Disadvantages?
Below, we have outlined the disadvantages to running a business as a sole trader.
Income tax liability
Business profits are taxed as personal income. Consequently, when your business starts making a profit, your tax rate will most likely increase. This is particularly true if you are employed as well as working as a sole trader, as your business income will be added to your employment income. Further, you cannot split business profits or losses with family members, and you personally liable to pay tax on all income your business generates.
Legal Liability and Asset Protection
If your business incurs large debts and then fails, creditors can attack your personal assets to repay the business’ debts. Further, your personal and business assets will be at risk if an individual or company makes a legal claim against you.
Workers Compensation and Superannuation
Sole traders do not pay workers compensation insurance on earnings from the business, as individuals cannot employ themselves. This also means, however, that if an accident occurs, the sole trader cannot receive workers compensation benefits. A sole trader should then take out adequate sickness and accident insurance to protect themselves.
Sole traders can only claim a tax deduction for superannuation contributions as a self-employed person.
Conclusion
As discussed in our earlier article in this series titled “The Advantages of Being a Sole Trader”, there are advantages to running your business as a sole trader, particularly when starting up your business with limited cash reserves. In fact, it may be the only financially viable option at the outset.
There are, however, disadvantages to running your business as a sole trader, particularly if you are trying to grow your company and want to make it profitable or if you want to limit your personal liability. You need to be aware of these issues. You should also consider and understand other business structures, and their respective strengths and weaknesses. Again, we will be exploring these other options over forthcoming articles.
If you are looking into how to set up your business or are considering changing your business structure, get in touch with LegalVision today. One of our business structuring experts would be happy to provide you with comprehensive advice specifically tailored to your needs. We can also assist you in setting up your business structure and advising you on what other needs your business may have.