To pay yourself as a sole proprietor, you’ll need a clear picture of your business's projected profits, the money you need to live and what you're going to pay in taxes. Keeping close track of your business finances will make all of this a whole lot easier.
What is a sole proprietorship?
A sole proprietorship is an unincorporated business entity with one owner. Spouses can also jointly own and operate a sole proprietorship.
A sole proprietorship:
- Doesn’t require you to file business formation papers with the state.
- Passes all business profits through to your personal income tax.
- Is popular with freelancers, consultants and bookkeepers.
How do I pay myself as a sole proprietor?
When you first had the idea to start a business, payroll was probably not something you considered. But once your business is off the ground, you have to decide what you'll pay your employees (if you have any)—and, just as important, what you'll pay yourself.
Here’s how to pay yourself:
- Take draws. A sole proprietor can “draw” money out of their business bank account at any time and use that money to pay themselves. If the business is profitable, the money in your account is considered your ownership equity and is the difference between your business assets and liabilities. To perform a draw, you would write a business check to yourself.
- Understand taxes. An owner’s draw is not taxed as a separate transaction by the IRS. Instead a sole proprietor declares all their business’s income and expenses on Form 1040 Schedule C. You’ll pay federal and state income taxes on your business’s net profit (income minus expenses), regardless of if you take a draw.
- Calculate a reasonable draw. You only file your personal income tax return once a year, and you may want to pay yourself on a more consistent basis. To do so, you'll need to look at financial projections or past financial performance and estimate your business's profits. Based on that number, you can set up consistent draws for yourself. And if your business does better than expected, you can give yourself a quarterly or annual bonus, too.
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How much do I pay myself as a sole proprietor?
Deciding how often to draw from your sole proprietorship profits is a personal choice and depends on your preferences. Some people opt for biweekly or once-a-month payments, while others choose a more or less frequent payment schedule.
It ultimately depends on what you're comfortable with and your living expenses. In general, there are two ways to determine your sole proprietorship salary when you are just starting out.
- Pay yourself the minimum you need to meet basic living expenses (with no frills attached) for the first several months, or until the business breaks even.
- Pay yourself what you are worth in the marketplace.
The second method is easier in the long run, because if you start out with a fair salary, you can keep paying yourself the same amount once your company becomes profitable. However, if your sole proprietorship can’t support paying you market worth, it’s okay to pay yourself the bare minimum until your business breaks even.
After that point, you can increase your take-home pay by giving yourself quarterly bonuses based on the company’s profitability. Once your business is showing steady profits, you can increase your salary.
How to project business profits
To determine your projected business profits, you’ll need to keep accurate records of your business assets and liabilities. That means not mixing personal and business finances because it could make it more difficult to prove which expenses were for your business.
Here’s how to keep your business and personal finances straight:
- Doing business as: Your business name defaults to your full legal name because, in the eyes of the IRS, you and your business are the same entity. To differentiate between the two, you can file a DBA or "doing business as," which will allow you to do business under a name other than your own.
- Business bank account: Once your DBA has been created, you can then open a business bank account under that name. This is the account you will use for all business income and expenses. Your business bank statements will then offer a clearer picture of how much the business earned and spent.
- Business credit card: If you wish to charge any business expenses, it also helps to get a separate business credit card.
- Accounting software: We recommend using business accounting software like QuickBooks to track business withdrawals and deposits, and the nature of the transactions.
Pros and cons of sole proprietorships
This type of business arrangement has some marked benefits and drawbacks.
Pros
Easy to start.
Don’t require a lot of paperwork.
Tax filing may be simpler as the owner can report business income and losses on their personal tax return.
Cons
You can be held personally liable for your business’s debts and obligations. That means creditors can go after your personal assets to get their money.
You generally owe self-employment tax and income tax on all business profits, even if you don’t draw the money out of the business.
Burnout is a real risk as you are taking on more (or all) business responsibilities.
