There are many things to consider when setting up a business, not least of which is what is the best entity to use for owning the business. There can be benefits of operating a business as a sole trader when the owner is still working while the business builds to a point where the owner can operate it full-time.
Where losses are made in the set up and establishment period, as long as the prime reason for changing from one type of business entity to another is not to reduce income tax, there is no reason why a business cannot be first operated as a sole trader and then change to operating as a company.
A major reason for changing from operating as a sole trader to a company can be where a business could be subject to being sued. This could be as a result of faulty products being sold, or as a result of a customer having an accident while visiting the business premises.
Q. I am thinking of starting my own business while I am employed. I will initially invest about $10,000 into the business to purchase equipment and keep a record of all my business-related expenses. I will operate the business from home with a portion used as a display area for customers. I would also be putting in a shed to set up as a consultation area, display, office, small workshop and storage area. I estimate the building will cost approximately $50,000.
In my first year, I believe I am going to make a considerable loss due to these purchases. I estimate my turnover after setting up to be $50,000 producing a $10,000 net profit. Am I right in thinking that, even taking into account my salary, I would be eligible for a considerable tax refund in my first year due to a loss from the initial equipment purchase, costs of setting up the shed and low turnover?
A. Unless your business turns over $20,000 in income in the first year, you cannot use the loss made to decrease your taxable income and create a refund while you are still employed. You can however carry forward any loss made in that first year, and claim it in a year that the $20,000 turnover test is passed.
Although you will be spending $50,000 in building the shed, from which you will be operating your business from as well as your home, you will not necessarily get a tax deduction for that $50,000. The immediate deduction for small business assets costing under $20,000 does not apply to buildings.
You will need to split the $50,000 cost between items relating to the structure itself and assets that would be depreciated. These assets could include heating or cooling installed in the shed or standalone assets such as office equipment.
As you will be operating from your home that will be visited by customers you should seriously think about changing from a sole trader to a company. In this situation in the event of the business being sued your home would not be at risk.