Business Trading Structures
A Sole Trader is basically when you go out and do something for money but are not actually employed as an employee by a business or person. You use your own IRD number for invoicing and all profits are declared in your personal tax return.
Being a Sole Trader is a good choice in that it’s easy and inexpensive to get started but if you’re looking at making profit over $70 000 (from 1 October 2008) you’ll be hit with the highest tax rates. If your business doesn’t work out you’ll be personably liable for any outstanding debts or reparation.
A Sole Trader is a good choice if you’re not expecting your business to grow very much over the next few years. For example you’re going to be a contractor with no employees and basically earning similar to if you were an employee.
A Partnership is very similar to a Sole Trader except more people are involved. Assets are not protected and partners are personally liable for losses and reparations. A Partnership trades with its own IRD number and the partners pay the Partnership’s income tax. Again these are inexpensive to setup and administer. The tax advantages are slightly more flexible than a Sole Trader but not as flexible as a limited liability company or Trust. Profits are declared across the partner’s personal tax returns.
Again a Partnership is a good choice if you’re not expecting your business to grow very much over the next few years and you and your partner(s) are going to be involved in the business. Also as with a Sole Trader a Partnership should only really be used when your income is similar to being an employee for each partner otherwise your tax bills could be higher than they need to be.
Limited Liability Partnership
These are very new and were designed more for large investment ventures than small businesses. At this time there’s not really any advantage for a small business to use a Limited Liability Partnership as a trading structure but we’ll keep an eye on these over time for any changes.
Limited Liability Company
A Limited Liability Company is a separate legal entity and the owners are the shareholders of the company. This means you are not your company so therefore your personal assets are reasonably well protected in case things don’t work out. Companies have a lower tax rate than the top personal tax rates and provide good flexibility at tax time. They do cost a few hundred dollars to setup and a little more than a Sole Trader or Partnership to administer but this is generally worth the extra cost for the benefits offered. A Limited Liability Company trades with its own IRD number and profits are declared across the both the shareholder’s personal tax returns and the company’s own tax return if appropriate.
For most small businesses a Limited Liability Company is a good choice for many reasons. These include…
Useful for any size of business
Company name is registered so provides name protection
Good tax advantages when profit climbs
Reasonable shareholder asset protection
From one to many shareholders allowed
A Limited Liability Company is a good choice if you’re looking to setup a business to grow, to employ people and to earn higher profits without paying more tax than is required.
Trusts are good for asset protection should things not work out but are expensive to setup, administer and have limited tax benefits relating to using losses to a personal advantage. They can be challenged for validity which may result in having no asset protection benefits at all and presently company tax rates are lower than those for a Trust.
It’s not that common for a small business to trade in a Trust as there are less expensive options such as Limited Liability Companies. If you do want to trade in a Trust you’ll need it set up by a good lawyer who specialises in doing this.
But please keep in mind
The tax man usually ensures you’ll pay quite a bit of tax if you’re profitable. The main thing is to select the best structure which suits your business and makes the best use of any tax advantages where possible. You really should seek advice regarding your new business from professionals before going much further.