Becoming your own boss requires a shift in thinking. You don’t have colleagues, an office to go to, a commute, or anyone directing your days. As a freelancer or consultant, the buck starts and stops with you.

Going out on your own requires a new level of personal responsibility. It’s up to you to create your schedule, find clients, pitch yourself, manage your money, and pay your tax.

If you’re a new sole trader who is coming from full-time employment, you would be used to having the tax taken out before the pay lands in the bank. It’s easy because it’s automatic. At tax time, you usually get a refund, not a bill.

What is a sole trader?

A sole trader is defined as an individual running a business. You operate under your own Australian Business Number (ABN) and invoice clients for the work you complete. In other words, as a sole trader, you are the business.

Operating as a sole trader is the simplest and most affordable business structure, making it lucrative for new freelancers and consultants. For example, companies pay tax on every dollar they earn, whereas a sole trader enjoys a tax-free threshold of up to $18,200, a nice benefit for side hustlers or people who plan to only freelance casually or part-time.

It’s important to know however that, unlike a company, sole traders are personally liable for financial or tax debts. There’s no distinction between private and business assets. You have full control over your business, meaning you’re responsible for all aspects of running it, including your tax.

Sole trader tax rates

Tax rates differ between freelancers. There is a sole trader tax rate but what’s more important is how much you earn. Here’s how it works:

Sole traders pay at the individual income rate. You pay tax on your taxable income, not the total amount you invoice for your services. Your operational expenses and superannuation contributions reduce your taxable income and your tax bill. For example, if you invoiced $60,000 for the year, paid $10,000 in expenses and $5,000 into superannuation, your taxable income is $45,000.

In other words, income minus expenses and superannuation equals taxable income.

The 2022-23 resident tax rates are:

Taxable income	Tax on this income
$0 - $18,200	No tax to pay
$18,201 - $45,000	19c for each dollar over $18,200
$45,001 - $120,000	$5,092 + 32.5c for each dollar over $45,000
$120,001 - $180,000	$29,467 + 37c for each dollar over $120,000
$180,001 and over	$51,667 + 45c for each dollar over $180,000

Sole traders are eligible for a Small Business Income Tax Offset credit of up to $1,000. Keep in mind the Medicare Levy and Compulsory Higher Education Loan repayment. The Medicare Levy is 2% of your taxable income and HECs-HELP is calculated based on a bracket system.

For example, if your taxable income is between $66,503 – $70,492, you’ll pay 3.5% (of the debt).

As you grow as a sole trader, it’s worth looking into a company setup. Companies are taxed at a set rate of 30%, which can be easier to forecast.

Calculating and paying your tax

There are a few different ways to stay on top of your taxes so you don’t get a big Australian Taxation Office (ATO) bill.

PAYG instalments

The ATO automatically enrols sole traders into Pay as you go (PAYG) instalments — where you pay your tax each quarter, based on the last year’s taxable income. You’ll get an ATO notification with the bill amount every three months. You can also make voluntary payments or one lump sum, by a specified date.

PAYG is designed to minimise your tax bill come July 1. Your tax return will determine whether you have tax owing or if you’ve overpaid with your PAYG instalments, which will result in a refund.

The ‘20% rule’

A simple and safe way to calculate your tax is to put 20% of every dollar earned into a separate bank account. If you earn $1,000, divvy $200 into your tax account. Let this accrue. You can use this account to pay for any bill that comes in, quarterly or yearly. This strategy is helpful because it strengthens the habit of putting money aside for tax.

Name the bank account ‘Not my money’ or ‘ATO’s money’, so you don’t get tempted to pull from it. Compartmentalise your money and create separate accounts for tax, superannuation, expenses, and your wage.

Your last bill + profit intention

Let’s say your previous tax bill was $10,000. If you usually send your invoices monthly, divide the $10,000 by 12. This will be around $835 per month.

Take this one step further and look at your future earnings. Calculate your expected taxable income for the year ahead and last year’s bill.

The Pay Calculator is a helpful resource you can use to forecast your upcoming tax bill.

Add your expected taxable income (profit minus expenses), add in the superannuation, and check the estimated tax.
Take the yearly figure and divide it by 12, then use this for your financial planning.
Your business profit will move up and down – and so will your tax.

This calculator is also useful in working out your hourly or project rates.

You can also view your tax information and make payments via MyGov.

» MORE: Working from home tax deductions

Paying tax means your business is profitable

While no one likes paying taxes — especially freelancers who see the money going out of their account — but it’s part of running a healthy business.

All it takes is a little perspective shift and you can learn to enjoy the process, rather than dread it. You might even find that you’ve overestimated the amount of tax you need to pay, so you’ll be pleasantly surprised at tax time.

Set up your bank accounts, create a habit of cross-checking what you’re putting aside with what you’re invoicing, and lean on the expertise of an accountant. For sole traders, good accountants are worth every dollar. You don’t have to do it all alone.