As a sole trader, you’ve probably heard somewhere along the grapevine that incorporating a company will help you save on your tax bill. Well, we’re here to bust that myth.
Basically, if you were to incorporate your very own company, you would eventually have to withdraw money from it as an individual – mainly either as a wage or via dividends. This is considered personal income that you’re required, by law, to pay tax on – and it’s the same amount of income tax you would have had to pay if you were a sole trader.
In contrast, if you were a sole trader, you’d pay the same amount of income tax and also have less paperwork.
Why might a sole trader choose to start a company?
There are a few reasons why a company structure might be better for your business, even if you’re the only one running it.
For example:
- you have a complex inventory system of goods which you need to maintain,
- you have creditors or investors supplying you with credit or a line of goods, or
- you have multiple directors or shareholders.
If any (or maybe all) of these situations apply to you, operating as a company might very well suit you better than being a sole trader.
How you and your company pay taxes
When it comes to finances, the biggest difference between being a sole trader and operating as a company is who actually owns the company.
As a sole trader, you are your business. Anything earned through your business automatically belongs to you (but don’t spend it all at once!).
In contrast, companies are separate entities. Anything earned through your business will belong to the company. In order to access company money, you’ll have to withdraw it – most commonly through the following ways:
Via wages
You can pay yourself wages through the company like a PAYE employee. You’d then pay income tax on this personal income at regular income tax rates, regardless of the fact that you own this company. You might be your own boss, but you still have responsibilities with the IRD!
Your company can claim your wages as a business expense, which lowers any taxable profit. Remember, any money that’s left sitting in the company’s bank account at the end of the financial year will be taxed at a rate of 28%.
Via dividends
If you choose to pay yourself in dividends rather than an ongoing income, these are generally paid from your post-tax profit. Meaning, the money that’s leftover in your company’s bank account after it was taxed at the company rate of 28%.
Furthermore there would be an imputation credit attached to the dividend. This lets the IRD know that this income has already been taxed at the company rate of 28%, but you would then be liable for the remaining tax at your marginal tax rate.
How Hnry helps
Here’s the thing: if you start a company when you don’t need to, purely to avoid paying too much in tax, well, you’ll not only still need to pay normal tax rates, but you’ll have a heck of a lot more paperwork on your plate.
If you have no real need to start a company, it’s probably easier to just stick with being a sole trader. It’s a good place to be. Plus, as a sole trader, you can use Hnry – an award-winning accounting service made specifically for sole traders.
For just 1% +GST of your self-employed income, capped at $1,500 +GST a year, we’ll calculate, deduct, and pay your:
We also file your tax return every year, all as part of the service. Oh, and we chase-up late paying clients on your behalf. And we manage and claim every expense you raise, so you get all the tax-savings you’re entitled to in real time.
Basically, we make it so that you never have to think about taxes again.
Save time, save money, join Hnry today.
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