Tax & Sole Traders

Tax obligations as a sole trader

A sole trader is a person who:

• Goes into business and trades on their own.
• Is personally responsible for all taxes and debts.
• Uses their own IRD number for the business.
• Can trade under a trade name, employ staff and register for GST. It’s important before you register for GST or as an employer that you seek advice from us, an accountant or a tax advisor about whether or not you need to register. There may be financial implications if you need to de-register at a future date.

A sole trader usually has no formal or legal processes to set up the business. The owner/manager is personally entitled to all profits, but is also personally liable for all business taxes and debts.

If you became a sole trader, you need to let IRD know so they can update your records

 

Risks of being a sole trader

Because a sole trader’s business isn’t incorporated as a separate legal entity from its owner, you can be directly sued by an unsatisfied customer which could put your personal assets like your family home at risk.

Unlike companies, sole traders can’t stop other businesses from using their name, but they can trade mark their brand as protection. It makes practical sense for sole traders to keep their personal and business accounts separate to make calculating their annual tax returns much easier.

 

Sole traders and tax

As a sole trader you work out your tax on your net profit (gross income less expenses), complete an Individual income return (IR3) and pay income tax on the individual tax rates.

You can’t pay yourself a wage, instead you take money from the business for personal use (drawings).

Sole traders can trade under a trade name, register for GST and employ staff. If they do register for GST or register as an employer, they must also be aware of the responsibilities associated with those.

 

Tax returns and record requirements

Your net profit (total profit minus tax-deductible business expenses) is simply taxed at individual tax rates. As your business doesn’t exist as a separate legal entity, in your first year of business all you need do is file a personal IR3 income tax return at the end of the financial year, just like any other individual who has to account for any non-salary or wage income.

In your second year of business you may have to pay provisional tax. All you’ve got to be careful of is making sure you keep a record of the money you take from your profits as living expenses. These drawings need to be carefully recorded for Inland Revenue so it clearly states which were for personal use and which tax-deductible business expenses were. For this reason, many sole traders use accounting software to accurately track their expenses.

Sole trader and drawings

If you are a sole trader you’re probably not paying yourself a wage, but simply taking money from the business when you need it for personal use. These takings are called drawings.

They are:

• a part of your profit and taxed accordingly
• not a deductible business expense when calculating your profit

Record your drawings in your cashbook so that you can reconcile your cashbook with your bank statements, ensuring that there is enough money in the business to cover any bills owing.

What are the tax rates for sole traders?

A sole trader is taxed at the individual taxpayer rates.

Example

Sales                                                     $200,000
less – all deductible costs            (120,000)

Net Profit                                               80,000

(This is your sole trader profit which is your taxable income as the business owner). To work out the tax to pay on $80,000 go to the tax calculator at the IRD site or simply use the following individual rates apply for the tax year 2016-2017

Each rate is for every $1 of taxable income excl ACC earner’s levy

1. $0 – $14,000                       – 10.5 cents 
2. $14,001 – $48,000              – 17.5 cents
3. $48,001 – $70,000             – 30 cents
4. $70,001 and over              – 33 cents
5. No Notification rate       – 45 cents
   

Independent earner tax credit (IETC)

From 1 April 2009 eligible tax payers earning between $24,000 and $48,000 will be entitled to the IETC which will lower the amount of tax to pay.

Income tax and provisional tax

Income tax and provisional tax are the same tax — provisional tax is just a way of pre-paying your annual tax bill.  As a small business owner, you’ll pay each tax year’s tax either in one lump sum, or by way of provisional tax in several instalments. If Inland Revenue tells you to pay provisional tax, set money aside — the first instalment may have to be paid soon after you’ve filed your tax return for the previous tax year.

Self-employed people as sole trader

If you are self-employed, you are responsible for your own tax.

This means that you must:

• Tell IRD, if you haven’t already done so, that you are in business
• Complete an Individual tax return (IR 3)each year, showing all your income and expenses, so we can assess the tax due (we will send you a tax pack each year once you tell us that you are self-employed)
• Budget to make regular payments of provisional tax and end-of-year income tax
• Register for goods and services tax (GST) if your turnover will be over $60,000 in a 12-month period.
• If you meet the tests for being self-employed, tax may still have to be deducted from schedular payments you receive.

On the Tax code declaration (IR 330) is a list of the occupations that are subject to tax, and the amount that will be deducted from each dollar you earn. If the type of work you do is listed there, you can claim work-related expenses against your income from that job.

 

Are you self-employed?

If you can answer “yes” to most of the following questions, it will usually mean that you are self-employed

Do you decide or control how you do the work?  For example:

• when you take holidays
• when, where and what hours you work
• the standard or quality of work
• how much you get paid and how

 

Do you invest or risk your own money in the activity in any way?

• Could you sell the business?
• Do you support the business with your own money? For example, have you lent it money, or provided any working capital? (Excluding shares obtained from any employee share purchase plan).
• Are you responsible for losses or your own bad management?
• Are you responsible for management and investment decisions for the business?
• Do you provide the major assets or working equipment needed for your job, (not just small tools, work clothing and/or vehicle to get to and from work)?

Do you provide or pay for your own training?

 

Are you responsible for getting the work done?

• Can you get other people to work with or for you, without needing to get permission from anyone else?
• Do you pay these people from your own funds?
• Are you free to do work for other people?
• Do you advertise on your own account?
• Do you arrange for someone else to do the job if you can’t (for example, if you are sick)?
• Does your work contract say you’ll be penalised if you stopped work, or left without completing a particular project?
• Do you have to correct unsatisfactory work in your own time and at your own expense?

 

If not self-employed – you are an employee

If you can answer “yes” to most of the following questions, you are probably an employee

• Do you have to do the work yourself, rather than hiring someone else to do it for you?
• Can someone tell you at any time what to do on the job, or when and how to do it?
• Are you paid at a set rate (for example, hourly, weekly, monthly, or per unit of production)?
• Can you get overtime pay or penal rates? (Please note that even if you are paid by commission or on a piecework basis you may still be an employee, especially if there are other people at your job who work on the same basis.)
• Do you work set hours, or a given number of hours a week or month?
• Does someone else set the standards for the amount and quality of your sales or output?
• Do you work at the premises of the person you are working for, or somewhere that person decides?
• Are other people who do the same sort of job as you treated as employees?
• Are you under an employment contract (either individual or collective), or any law that says how your relationship with your “employer” should be run?
• Are you prevented from doing work for anyone else?
• Do you have to follow the rules or procedures of the person you are working for?

If you answered yes to most or all of these questions, then you will be taxed as an employee on PAYE rates.

If you are not currently being treated as an employee (with PAYE deducted from your pay), you will need to contact Inland Revenue and they will help you sort things out with your employer, so your income is taxed correctly.