Becoming self-employed, going freelance or making the transition from PAYG worker to an independent earner can be a daunting prospect.
What puts most Australians off from making the switch, even when they have both the skill and intention, is the concern around financial independence. This both relates to the worry of managing their own income after switching from a regular salary, but also how to navigate the often complex and sometimes overwhelming issue of taxes, super, GST, and beyond.
Even those who maintain their salaried role, but earn a bit on the side can get mixed up with how to ensure they’re contributing the right amount of income tax. There are also a significant number of those already in self-employment who aren’t meeting their tax requirements, more often than not without realising.
For obvious reasons, 2020 saw an increase in people both taking the leap into independent earning as well as a sharp uptick in Australians starting to think about it - searches of ‘self-employment’ increased significantly in a year-on-year comparison.
If the worries about tax are what is holding you back then help is on the way.
Here are some answers to the most frequently asked questions our experts get that should give you some relief to tax-related worries:
Do I have to register a Pty Company to earn income independently?
In short, no.
To expand, for many years there’s been an incorrectly-held belief that all freelancers, contractors, or consultants are required to register a Pty Company.
This, however, is an unnecessary complexity that can lead to increased cost and admin headaches, with no real benefits. There is a common misconception that having a Pty Company can lead to lower tax rates on income. Those independent earners who trade as a company tend to draw out all income from the company any time it’s earned - and the tax rates for individuals are exactly the same whether you get paid directly by your client, or whether you pay yourself out of your own company. Being paid through your own company doesn’t necessarily reduce your own tax rate at all.
These days, most independent earners prefer the flexibility of being an ABN Sole Trader instead. You can register a business name, have a .com.au website domain, register for GST, and claim business deductions - without any of the additional hassle of company tax filings. It is the simplest and easiest way for the self-employed to do business.
How much should I set aside for tax?
There is an old-school theory that you should set aside 20 per cent of your income, or 35 per cent if you’re GST-registered. The problem with this broad recommendation is that for everyone it is always wrong.
For a start, your tax rate is highly unlikely to be a nice, round number - and so this traditional advice will always leave you either holding back too much or too little.
If you’re wanting to ensure that you’re not over or underpaying the right amount of tax, then you need to have a strong understanding of the following: your income tax rate depends on how much you earn, and your eligible business deductions for the whole financial year. If you have an estimation of both of these numbers, you can work out your predicted net income, therefore your tax rate, and ultimately the amount of tax you’ll need to pay. As your income tax fluctuates you will need to do these sums throughout the year to ensure your amounts are on track.
Another consideration is that if you are GST-registered, this is not interchangeable with income tax and people can often get confused as to how each works. For GST you’ll charge a flat 10 per cent in addition to your usual prices, and this 10 per cent is payable to the ATO. If you receive any GST, it’s best to put this aside in its entirety, immediately. Any sole trader earning $75k in a year (exclusive of GST) needs to be GST registered and charge GST to their clients. If your turnover is below the $75,000 mark, then registering for GST is optional. Once registered, (and regardless of your subsequent turnover), you must include GST on top of your prices, and you can claim back the GST you’ve paid on your business purchases.
Working things out accurately is far more useful than just putting aside an approximate amount - as by approximating you’re either denying yourself money or setting yourself up for a tax bill at the end of the financial year.
How do I work out my income tax rate if I have multiple sources of income?
Your income tax rate is based on your total income, minus allowable expenses, for the financial year. If you have multiple sources of income, your tax rate is based on the sum of all of these - there aren’t different income tax rates for different types of work.
So to work out your tax rate, you total up all the income you’ve earned across all sources, and then deduct the total of all your eligible business deductions. The resulting number will be the number used to calculate your tax rate, based on this year’s ATO tax rates.
The tricky part comes when you have a salary job alongside your self-employed income, where your employer pays PAYG taxes on your behalf. In this scenario, your employer most likely won’t know about your self-employed income, and your employer may be under-deducting for tax.
For example, if you had a PAYG salary job earning $30,000 per year, your employer would be deducting tax from you based on that being your only income for the year.
If you also earned $30,000 independently that year, your income tax rate would need to be set based on the sum of the two - $60,000
So even though your employer had been taxing your income, they would have been taxing you at far too low a rate, leading to frustration, confusion, and tax bills at the end of the financial year.
It’s always worth engaging a professional to make sure you know the exact amount of all your taxes that you should be paying, based on your different sources of income.
How do I plan for retirement when I’m self-employed?
A lot of independent earners are unsure about the exact procedures and legal requirements for superannuation when it comes to their self-employed income. The simple answer is, contributing to super is not mandatory if you’re an independent earner, however, anyone can make voluntary super contributions at any time.
It’s also worth noting that as a self-employed individual you aren’t guaranteed any super contributions from your employer. There are certain circumstances when contractors work full time for one employer, that employer is liable to make employer super contributions, however, that can depend on the contract with the employer, and doesn’t necessarily apply to all independent earners.
Our recommendation to independent earners is that it is always useful to get into good financial habits. We advise putting aside money for the future whenever you are able to - whether that’s for savings, investments, or superannuation.
Building up these regular habits right away doesn’t have to drain your income - just putting away a percentage of your earnings each time you get paid is a really simple way to start, to get a steady rhythm going. It’s never too late to start putting a few dollars away for the future - a bit like tax, you don’t want to be caught short when the time comes.
As I’m self-employed what business expenses can I claim as deductions?
As an independent earner, there are lots of costs you will incur in the course of your work, that are perfectly fine to claim as business expenses. If you are purchasing equipment for work purposes, incurring costs purchasing supplies, and particularly if you are working from home, there are many associated costs that can be claimed as deductions, to reduce the amount of your income you pay tax on. The best way to think about it is ‘if this expense is a requirement of me doing business, it could be eligible as a deduction'. There may be things that you can claim as deductions, that would not have been claimable if you were a salaried employee.
You need to be sensible though, we’ve heard some horror stories about the sorts of things that some people have tried to claim - holidays, jet skis, fancy cars - only for the ATO to find out, and take serious legal action.
Any good accounting professional should be able to provide you with lots of details about what is and isn’t claimable - and if you get one that says “don’t worry, I’ll claim that for you as no-one will ever check” then it’s time to run a mile.
The ATO are working hard every day to clamp down on dodgy expense claimants, and the so-called ‘professionals’ that encourage them to do it - so it’s always best to stay on the right side of things and avoid any nasty surprises.