How to Pay Yourself as a Sole Proprietor

Want to pay yourself as a sole proprietor? Learn the step-by-step process for paying yourself as an employee from your own sole proprietorship.
Pay Yourself as a Sole Proprietor

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Are you a sole proprietor who is looking for ways to pay yourself? Then you are most welcome to our blog. 

If you are doing business as an owner, then you already know that being your own boss comes with lots of benefits and challenges. Paying yourself as a business owner is one of the biggest challenges you may face. When you first thought about starting the business, you probably didn’t consider the salary.

As a sole proprietor, you’re not just the boss; you’re also the employee. You can ensure that you are appropriately rewarded for your labor and ensure your own financial security by paying yourself a fair salary or designating a monthly distribution from your profits. 

And that means you must find out how to pay yourself as a sole proprietor. Sadly, the answer won’t be the same as what you expected. When you do business and earn money, state, federal, and local agencies, along with the IRS, also claim a piece of it. Don’t worry, though; we’re backing you up! 

In this blog, we’ll tell you the simple steps to ensure you’re compensating yourself as a sole proprietor. So take your favorite beverage and get ready to learn how to give yourself the paycheck you deserve!

What Is a Sole Proprietorship?

The owner of a sole proprietorship, which is an unincorporated business structure, is either a single person or a married couple who manages the business and is liable for all debts and losses. You aren’t required to register with the state to form this business structure. 

Also, it requires less paperwork and formalities. You can easily establish a sole proprietorship at a lower cost. In fact, a sole proprietorship is established when you enter into a contract to sell products or services. 

If you work for yourself and make money, that’s self-employment. When you are a self-employed person, you automatically become a sole proprietor unless you work with others or meet other standards, such as forming an LLC or corporation.

Example of Sole Proprietorship

There are many examples of sole proprietorships. Included following:

  • Tutors
  • Business consultants
  • Social media specialists
  • Grocery stores
  • Freelancers
  • Photographers
  • Landscapers
  • Digital marketers, etc.

How to Pay Yourself as a Sole Proprietorship

You may be wondering about asking us, “As a business owner, how do I pay myself?” It can be more difficult to pay yourself than to pay employees. You may feel daunted. But, to be honest, it’s not as hard as it seems. You just need to maintain some essential steps, which are described below:

  • Separate Bank Account: As a single proprietor, you can pay yourself by taking an owner’s draw. Before you pay yourself, you should first set up a different business bank account because keeping your work and personal finances separate makes it much easier to handle your money. 

You can create a business checking account under your own name if you are not doing business under a different name. To use a different business name, all you need to do is file a DBA or “Doing Business As.”

It’s best to have a credit card for the business to keep all sales, income, and checks to pay business expenses directly from the business into that business account.

  • Decide Your Salary: You can determine a salary to pay yourself, just as a sole proprietor pays employees. Choose a reasonable amount for you, depending on your business and profits. For this system, you have to use a payroll system along with withholdings and an EIN (Employer Identification Number).

  • Owner’s Draw: You should transfer money from your business account to your personal account once your accounts are opened and running. When you transfer money instead of receiving a salary or withdraw money from the business account to the personal account, this is addressed as “the owner’s draw.” This allows flexibility in your payments. You can take more or less money based on your business activity.

You should remember that owner’s draw doesn’t involve any kind of formal payroll process or withholdings, meaning you’ll have to manage your individual tax obligations on your own.

  • Bookkeeping as Distribution: After completing payment, show your transactions as records in bookkeeping software. This will help you understand how your business’s cash flow can change over time. You can also use an online bookkeeping service for this. 

  • Make a Note: Then note your revenue, expenses, payments, and profits so that you can use records to calculate and pay your estimated taxes by filing a tax form at the end of the year. 
How to Pay Yourself as a Sole Proprietorship

Why Should I Pay Myself?

When you pay yourself, it means that you value your efforts and time and are motivated to grow your sole proprietorship business. Basically, you need to pay yourself for three different reasons. 

  • Drawing the Bare Minimum:  The first reason for paying yourself is to meet the expenses. When you have savings but want to get the business off the ground, you must draw the minimum amount to meet the expenses. You must reinvest the money back into the business if you pay yourself for this reason.

  • Owner’s Worth in the Marketplace: Another reason to pay yourself is to recognize your worth. As a sole proprietorship owner, you may think that you deserve the same earnings as other owners of businesses or industries in your locality. So, you need to consider future growth opportunities, the cash flow of the business, paying off business debts, how much you can save in business, etc. 

  • Quarterly Rewards: If your business runs well, you may need to reward yourself with a quarterly bonus and increase your salary eventually. Before this, you must keep track of your expenses and implement a sustainable bookkeeping routine. 

We suggest the second reason. This allows you to make a potential income to keep paying yourself as the business grows. Also, you can use it to pay the IRS (Internal Revenue Service) frequently. But sometimes, drawing the bare minimum is needed when you lack capital.

Calculation of How Much I Should Pay Myself

Now that you know why and how to pay yourself as a sole proprietor, it’s time to know how much you should pay yourself as a business owner. Honestly, there are no special legal obligations or rules about calculating the exact amount you may take from your business. You need first to calculate the amount of expected profit and the period for drawing checks from the business. We suggest determining your self-payment based on the following instructions: 

  • Keep enough cash on hand to cover your tax obligations, which are usually approximately 30% of your profits.

  • Ensure you save enough monthly money to pay for the basic business costs, such as utilities, payment processing, software, advertising, and more. 

  • Withdraw enough money to cover your necessary living expenses.

  • When you decide to pay yourself, consider how much other business owners pay employees at regular jobs. 

  • Create savings and a cash reserve to pay your bills for a few months in case you run out of money or have a rough financial patch.

  • Consider investing or saving for retirement if you have extra money. Contributing to a retirement account can help you pay less in taxes.

For example, if you earn $13,000 in a month but your monthly business expenses come to $3000, leaving you with a $10,000 profit. Then, you set aside $3,500 for taxes, leaving you with $6,500. From that, you put aside $500 for cash reserves and deduct $1,000 for retirement. Then you have $5000. So, your self-payment is $5000.

How Sole Proprietors Are Taxed

Though you are not doing business with anyone or don’t have an employer, no one deducts taxes from your payments every time you draw money from the business. But as an owner and an employee, you may have special tax obligations, which wouldn’t be the case if you were an employee of another person. Here are a few key factors that affect how sole proprietors are taxed: 

  • Filing Business Income: As a sole proprietor, you must file your business income and expenses on Schedule C (Form 1040). Using this form, net business profit can be determined, which must be reported with your overall income on your tax return as an individual.

  • Tax on Self-Employment: Sole proprietors must pay self-employment taxes to the IRS, which covers Medicare taxes and Social Security. This is computed using your business’s net profit. You must complete Form 1040-SE to figure out and report self-employment tax liability. 

  • Estimated Tax Payments: All self-employed individuals, including sole proprietors, are required by the IRS to report and pay estimated taxes if they estimate owing $1000 or more when submitting their annual return. You can calculate the estimated quarterly due taxes by using Schedule ES (Form 1040).
How Sole Proprietors Are Taxed

Tax laws can be complicated and subject to change. We understand your problems. So we advise you to talk with a business legal expert or a qualified tax professional to ensure you are following the law and maximizing your tax strategy. 

We can give you advice that is specific to your situation and help you find your way through the tax system. Our premium business consultation enables businesses to overcome challenges, increase revenue, and achieve ultimate growth. We can give you advice by considering your situation and helping you navigate the tax environment successfully. 

Final Thoughts 

In summary, you should carefully consider various factors to pay yourself as a sole proprietor.  By using the ideas we’ve talked about, you can ensure that you receive fair compensation for your hard work and dedication. Keep in mind that paying yourself not only rewards your efforts but also helps you maintain personal financial stability.

So go ahead, take care of yourself and your business, pay yourself what you are worthy of, and enjoy the reward for your hard work. 

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