The golden rules to avoid a massive tax bill as a sole trader

It happens every year. Sole traders around the country tread steadily toward the end of financial year on 1 July, until suddenly, their chest tightens with panic.

Hot on their lips is the nail-biting question: what if I don’t have enough coin in the bank to pay my tax bill?

Most sole traders will know that they’ll need to file their business tax return to the ATO between 1 July and 31 October. However, unlike regular taxpayers who may receive a refund, sole traders will generally receive a bill.

If you earned more than you thought you may get a shock. But rest assured, with a bit of due diligence, this all-too-common sole trader catastrophe can be averted. All you need is a few software tools…and two separate business bank accounts! (A fundamental understanding of your tax schedule is also very helpful.)

Take heed of our sound tactics to better manage your income and taxes to avoid a massive tax bill in the future.

1) Know your tax bracket and tax rates

To understand your tax rate as a sole trader business, simply use the ATO’s income tax calculator for accuracy and peace of mind.

2) Create separate business and personal bank accounts

Before we look at avoiding a tax bill, follow one golden rule:

Never use your personal accounts. Always use business bank accounts.

It might sound simple, but so many sole traders fall into this simple trap. As soon as you mix personal and business accounts and cards, you’ll have a seriously tedious task ahead – separating out all of your business expenses from personal expenses come tax time.

The relatively simple act of using separate bank accounts to manage your sole trader finances not only gives you one source of truth (when it comes to tax compliance) but means you can easily connect just your business accounts to your accounting software. This will allow you to automate much of your compliance and tax duties to save you time.

3) You need a second account for taxes only!

Once you’ve established separate business and personal accounts, it’s wise to then open a second business account – a simple business transaction account with the sole purpose of storing and paying anticipated taxes.

Call this your tax fund account. It’s not to be used for anything else.

You shall not draw funds from this account except to pay taxes. You have to be disciplined! Don’t even think about getting bank card to access it – if the bank sends you one, cut it up.

(Otherwise, you’ll run the risk of using this tempting pool of cash to pay for business or personal expenses…)

4) Anticipate your tax bill and save it

Right, so how much do you need in that tax fund account? How much tax will you be paying this year and what do you need to lay aside? Only when you know this can you budget properly.

The best way to start budgeting for this is by looking at what you owed and earned in tax the year prior. Failing this, use the ATO’s income tax estimator calculator to get a solid estimate.

5) Pay in instalments

Ok, so you know how much you need in your tax account. Start paying into this regularly with an overestimate of your tax budget. You’ll never go wrong if you overestimate. However, you don’t need to build up the whole yearly lump sum – instead you need to be paying in instalments.

Use PAYG

If you’re operating above the tax-free threshold, your return will indicate this. You’ll automatically be entered into the PAYG (pay as you go) scheme, which allows you to pay your tax in quarterly instalments.

Make voluntary payments

You can even make voluntarily payments over your estimate, and you may find yourself with a tax return, not a tax debt. Winning! This is all done through your MyGov account.

Read more from the ATO on how to use PAYG to pay your tax in instalments.

6) Using an advisor to minimise tax

Many sole traders and small businesses use a registered tax agent to assist them with reporting. Not only are they’re adept at picking up on tax reduction strategies, their services also ensure compliance. There are many easy-to-miss tax deductions that you’ll incur as a sole trader, highlighting the importance of professional tax advice.

They can also provide tailored strategies for avoiding a tax bill, perfect for your unique circumstances, preferences, and mode of operation.

If you need help finding an accountant or bookkeeper near you, feel free to use our advisor search tool.

If you need further advice on sole trader tax, we urge you to visit the ATO