How does tax change for different business structures?

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Taxation
By
John Liston
John Liston
Director | Adviser
April 28, 2020
minute read

A guide to the tax rate for different business structures

Different business structures offer different tax rates and incentives, and depending on the type of business you run, one structure might be a more tax effective option.

This article discusses the different tax rates for common business structures in Australia, so you can gain a thorough understanding of what’s required for your business.

Liston Newton Advisory are available to provide business owners with expert tax advice for your business structure. Get in touch with us to discuss how your business can become more tax effective.

Tax paid as a sole trader

Under a sole trader structure you get taxed at the marginal individual tax rate. This means that the more you earns, the higher tax percentage you pay.

Individual tax rates 2020-21

[table]

[thead]

[tr]

[th]Income[/th]

[th]Tax Rate[/th]

[/tr]

[/thead]

[tbody]

[tr]

[td]$0 – $18,200[/td]

[td]0% - no tax paid[/td]

[/tr]

[tr]

[td]$18,201 – $37,000[/td]

[td]19% on each $1 over $18,200[/td]

[/tr]

[tr]

[td]$37,001 – $90,000[/td]

[td]$3,572 plus 32.5% on each $1 over $37,000 (+ 2% Medicare levy)[/td]

[/tr]

[tr]

[td]$90,001 – $180,000[/td]

[td]$20,797 plus 37% on each $1 over $90,000 (+ 2% Medicare levy)[/td]

[/tr]

[tr]

[td]$180,001 and over[/td]

[td]$54,097 plus 45% on each $1 over $180,000 (+ 2% Medicare levy)[/td]

[/tr]

[/tbody]

[/table]

Example

A freelance graphic designer makes $150,000 in this financial year. They have $30,000 of expenses. Therefore, their profit is $120,000.

This $120,000 is added to their personal income.

Based on the 2020 financial year tax rates, they will pay $34,117 in tax.

Tax paid under a partnership structure

Under a partnership structure, the partnership entity itself is required to lodge a tax return. Each partner is then required to pay tax on 50% of the partnership’s net income.

Example

For example, two friends form a partnership to run a legal practice:

  • They have $500,000 of income in the financial year, with $200,000 of expenses to run the business.
  • This means the partnership has a profit of $300,000.
  • As the partnership is its own tax entity with a unique tax file number, it must lodge a tax return.
  • Each partner then has to report 50% of the profit on their personal tax return, equalling $150,000 per partner. Based on the 2020 financial year tax rate, tax payable on this amount would be $45,997.

Tax paid as a family trust

As a family trust is a type of trust structure, it typically pays zero tax on income generated within the trust. Instead, this income is distributed to the trust’s beneficiaries, who each pay individual tax rates on their portion of the income.

A family trust is also known as a discretionary trust, which means the income is distributed at the discretion of the trustee.

This enables the trust to distribute the income in the most tax-effective manner available.

It’s important to note that if a business owner pays themselves a salary from the trust’s income, the owner pays tax on this salary on a PAYG basis. Then, they pay tax at their personal tax rate on any additional profit that’s distributed to them.

There is one exception to a family trust’s no-tax situation. If the family trust chooses or is unable to distribute income to its beneficiaries for any reason, then the trust itself is taxed at the highest marginal tax rate. Your tax adviser can guide you through this situation.

Example

A business operating under a family trust structure earns $200,000 profit that year:

  • The business owner is able to split the income among the three beneficiaries of the trust — their family members.
  • Split equally, each family member receives approximately $66,666 each in income.
  • As the income for each family member is taxed at their individual tax rate, the combined tax payable is approximately $40,000.

When compared to a business operated under a sole trader structure, the business owner would be required to pay tax on this income at the highest marginal tax rate. This would result in around $67,000 in tax. The tax benefits for a family trust structure are obvious.

Tax paid as a unit trust

Similar to a family trust a unit trust itself doesn’t pay tax.

Under a unit trust structure the beneficiaries, or stakeholders/shareholders, receive their distribution of the trust’s income under a fixed percentage. This percentage is proportionate to the number of units/shares they hold in the trust. This income is then taxed to each shareholder individually under their individual tax rate.

In some circumstances there is income that no shareholders are entitled to. In this instance the trustee is taxed on this income at the highest marginal tax rate.

Example

A business operating as a unit trust earns $750,00 profit in the current financial year. The trust has five beneficiaries, with the distribution of income as follows:

  • Person A and Person B are entitled to 25% of the income, each receiving $187,500, and therefore paying $57,472 income tax.
  • Person C and Person D are entitled to 20% of the income, each receiving $150,000, and paying $42,997 income tax.
  • Person E is entitled to 10% of the income, receiving $75,000, and paying $15,922 income tax.

Tax paid as company

A business operating under a company structure is charged tax based on the size of the company.

As the company structure itself is its own legal entity, the company is required to lodge a tax return and pay tax on its income. Employees of the company must lodge their own individual tax returns.

Company tax rates 2020-2021

[table]

[thead]

[tr]

[th]Company Type[/th]

[th]Annual Turnover[/th]

[th]Tax Rate[/th]

[/tr]

[/thead]

[tbody]

[tr]

[td]Small Business[/td]

[td]Less than $10 million[/td]

[td]27.5%[/td]

[/tr]

[tr]

[td]Company[/td]

[td]$10 million or higher[/td]

[td]30%[/td]

[/tr]

[/tbody]

[/table]

In the 2021–2022 financial year, this 27.5% tax rate will reduce to 25%, with the threshold increasing to $50 million.

Much the same as a family trust, where a business owner pays themselves a salary from the company’s income, they’re required to pay tax on the salary on a PAYG basis. They then pay 27.5% tax on any profit left within the company.

The final word

As you can see, you pay a different tax rate for different business structures, and the way you structure your business can limit or enable a range of varying tax benefits. It all depends on what you’re aiming to achieve.

For a complete list of Australian tax rates, head to the ATO's website to find out more.

For thorough, holistic tax advice on your business structure, get in touch with Liston Newton Advisory today. Our advisers can talk through your business structure, determine your growth plan, and help you determine which structure is most appropriate for your business.

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