Setting aside money for tax as a sole trader

Why the bill surprises people

Employees never see their tax. Sole traders receive the gross amount, spend some of it, and meet the tax 4 to 16 months later. In the first year there are no PAYG instalments, so the entire year’s income tax arrives after the first return, at the same time as instalments for the following year begin. GST is worse: it is not even your money, but it sits in your account looking like income.

Part 1: GST

If you are registered, one eleventh of every GST-inclusive payment you receive belongs to the ATO. A $2,200 invoice paid is $200 of GST. Move that amount to a separate account when the payment lands, or once a week as a batch.

You will get some of it back as credits on your business purchases, and that shows up as a smaller BAS bill than the account holds. Leave the surplus there; it becomes a buffer. If you want to be precise, FlowFi shows the running 1A minus 1B figure for the quarter so you know exactly what the BAS will be.

Part 2: Income tax

Income tax is on profit, not income, so the right percentage depends on your margins and your bracket. A workable approach:

• Estimate your profit for the year (income minus deductions).
• Use our sole trader tax calculator or the ATO rates to find the tax on that profit, including the 2% Medicare levy.
• Divide by your expected income to get a percentage of each payment to set aside.

For a sole trader with typical margins and a profit in the middle brackets, that percentage often lands between 25% and 30% of profit. If you have a part-time job as well, your business profit is taxed at a higher marginal rate, so the percentage should be higher. When in doubt, round up; a refund is a nicer surprise than a bill.

A worked example

A registered tradie receives $11,000 (GST inclusive) in a week.

• GST: $11,000 ÷ 11 = $1,000 to the tax account.
• The remaining $10,000 is income. Say expenses run at 35%, so profit on this week is roughly $6,500.
• Income tax at an assumed 28% of profit: $1,820 to the tax account.
• Total set aside: $2,820, leaving about $8,180 for expenses and drawings.

Over a year, the tax account holds the GST for four BAS payments and the income tax for the return or the instalments, and the tradie never has to find money in October.

Make it automatic

Most banks let you set a recurring transfer, and some let you sweep a percentage of deposits. Set it up once for a fixed weekly amount based on your average, then adjust quarterly. If your income is lumpy, do the transfer manually each time a large payment lands, the same day. The rule is that the money moves before you look at the balance.

Once PAYG instalments start

After your first return, the ATO will usually enter you into PAYG instalments, which are paid quarterly on the BAS. From then on the income tax you set aside is drawn down each quarter rather than once a year, which is easier. Keep setting aside the same percentage; the instalment is based on last year and may be lower than this year’s actual tax.

If you are already behind

Lodge everything that is due even if you cannot pay; the late-lodgement penalty is separate from interest and is avoidable. Then set up a payment plan through ATO online services. Small business plans for moderate amounts can usually be arranged online. Start the set-aside system at the same time so the plan clears the old debt while the new tax is funded, rather than rolling one into the next. It takes about a year to get straight, and it is worth doing.