Are You Paying Yourself In a Sole Proprietorship?

Starting a new business is exciting. Between countless hours of planning, research and development, and hiring employees, there are a lot of moving parts to take into consideration as well. One extremely important element to any new business is managing payment, not only for you but for your employees. 

While you may be familiar with how receiving it as an employee works, paying yourself as an owner is an entirely different process. In this article, we are going to cover how to pay yourself as a sole proprietor and ways to make the process easier to understand and manage. 

When owning a small proprietorship, there are many details that can give you a headache. Figuring out how to pay yourself shouldn’t be one of them.

What is a Sole Proprietorship?

Before we dive into discussing payment, let’s go over what makes up a sole proprietorship. First and foremost, sole proprietorships are the simplest form of business setup. The IRS states that a sole proprietorship is “someone who owns and operates an unincorporated business by himself or herself.” 

This means that you own and run your company without any partners. Additionally, all gross income comes to or passes through you, and is reported on your tax statement. 

Common forms of sole proprietorships are freelance workers (designers or writers), as well as attorneys and consultants, but cover a wide array of services. While sole proprietorships are often a one-person operation, they can hire employees in which case they have to file the proper tax documents.

Furthermore, if you co-own a company with your spouse, this is too considered a sole proprietorship. 

Why Start a Sole Proprietorship?

Oftentimes, sole proprietorships spring up organically. Are you a web developer who designs websites for money? You’re a sole proprietor. Maybe you are a landscaper, who is paid for your hedge trimming services; you’re a sole proprietor as well. In fact, sole proprietorships don’t have to incorporate your business with the state. Because of this, starting a sole proprietorship is oftentimes much easier than creating a larger LLC. 

Furthermore, as a sole proprietor, you get to call the shots. Since you aren’t working under a boss, you have full control over your business’s marketing, strategy, and finances, as well as some control over how to pay yourself. (which we will be going over in more depth later). 

Also, filing taxes is much easier for a sole proprietorship when compared to other business models. The only things you will need to obtain in order to get your business started are the permits and licenses required by your state, depending on the nature of your service. 

How To Pay Yourself In A Sole Proprietorship

In most business scenarios, employees are paid a salary, which is a set wage or amount paid out at regular periods. However, in the case of a Sole Proprietorship, the owner pays themself in the form of a draw. Let’s take a closer look at what it means to take a draw and the implications it has for sole proprietorships

What Is A Draw

A draw is simply when an owner takes funds out of their business for personal use. Unlike a salary, a draw can be done at any time and is not a fixed amount. However, there are certain things to note about draws. 

First, you do, in fact, have to make them. This may seem obvious, but if your business is struggling to break even, you may be tempted to forgo making draws in order to be profitable. 

However, this can be a problem if you have received a business loan, as many sole proprietorships do. Lenders want to know that you are able to validly make profits, without cutting corners and not paying yourself. 

You can, however, adjust the amount of your draw. For instance, if your business is doing particularly well, you can take a larger draw. Additionally, if your business starts to grow and succeed, you can give yourself quarterly bonuses. 

However, it’s important to note that as a sole proprietor, the more you pay yourself through draws, the less money you will be able to put towards business expenses. 

Example Of a Draw

Imagine that Jason starts his own landscaping company and is a sole proprietorship. Jason puts in 30,000 dollars worth of equipment and cash to start his business. This gives him $30,000 in owner’s equity. Throughout the year, Jason makes $25,000 in profits, which brings his owners equity from $30,000 to $50,000. 

Since Jason is the sole proprietor, he is able to make a draw of any amount up to $35,000. If he chooses to draw $25,000, he will then have $25,000 left in owner’s equity. Regardless of the amount he chooses to draw, he only pays taxes on whatever the company makes in profit since these draws are considered business expenses. 

When Jason makes a draw, he writes himself a business check, rather than simply pocketing his client’s money. It’s important to take this measure so that all of his finances are properly recorded when it comes time to file taxes. 

How Much To Pay Yourself As a Sole Proprietorship

There are a few ways you can determine how much to pay yourself. Several factors that you should consider are your: 

  • Business Performance
  • Business Growth
  • Personal Expenses

For businesses that are just starting out, it may be appropriate to determine the bare minimum for how much you need to simply survive and draw that amount. Of course, as your company grows, this amount can grow as well. Secondly, you can base it on your basic worth.

By keeping track of all aspects of your finances, you can project how much your company is worth. Paying yourself your basic worth includes your market worth, with an added percentage. In this case, you are considering all of the personal sacrifices that go into running a business and compensating yourself for them instead of simply taking the bare minimum. 

On another note, it is also important to calculate how much you will have to pay in taxes at the end of the year to ensure that you have sufficient funds. 

Understanding Equity

While determining how much to pay yourself in a sole proprietorship, it is helpful to have at least a basic understanding of Equity. Essentially, when an individual contributes funds, equipment, or any other asset to a business, they receive equity, which allows them to take money back out of the company. Equity is based on the balance sheet formula, which calculates the equity left over after balancing assets and liabilities. 

An asset is a resource held by the business, such as inventory, equipment, or cash. Liabilities are payments that the company has to make, such as bills, rent, and debts incurred by the business. 

Companies pay for their liabilities by selling assets. Any money left over after paying off assets is equity. This amount of money, or an equity balance, will help determine how much money the sole proprietor is able to withdraw from the company. 

How To Keep Track Of Your Money As a Sole Proprietorship

If you are planning on paying yourself in a Sole Proprietorship, it is extremely important to be thorough when managing all financial records. Since there can be a lot of overlap between business and personal expenses, keeping the two separate can be a challenge. 

Let’s go over some measures you can take to help keep everything in order. 

Credit Cards

One way to keep tabs on which purchases are made for businesses is by opening a business credit card that is separate from any personal card. Seek Capital can help you compare different credit cards and help you find the best fit for your business. 

Use this card for any products or services that you purchase for your business. This way, when reviewing all of your receipts and transactions, you’ll automatically know that all purchases made on that particular card were for your business. 

Separate Bank Accounts

Another helpful method for keeping business and personal expenses separate is having two separate bank accounts. Since sole proprietorships are not seen as corporations by the IRS, your business name will default to your legal name. 

In order to open a bank account under a different name, you will be required to file a DBA, which stands for “Doing Business As” and will allow you to do business with a name other than your own. 

Once this business account has been opened, use it exclusively for all business income and expenses including credit card sales receipts as well and ACH deposits. When you make a draw, it will be from this business account, and then deposited into your separate business account. The statements pertaining to the business account will help you determine your profits, and subsequently how much to pay yourself. 

Accounting

For a sole proprietorship, staying on top of your accounting will help every aspect of your business run smoothly. Since small business owners have a lot to juggle and often don’t have time to also be your own accountant. 

That’s why using an online accounting service can help take care of all the heavy lifting, and give you easy-to-understand breakdowns of all your expenses, receipts, and profits.

How to File Taxes As A Sole Proprietorship

As mentioned above, you are actually not required to pay taxes on any draws you make, as the IRS considers them to be business expenses which allows you to write them off. However, you will be required to pay self-employment taxes, which include Social Security and Medicare taxes. These taxes are applicable to your total net income, which is the amount of profit your business makes. 

Since the IRS sees you and your business as one entity, you are not required to complete an entirely different return for your business. Instead, you simply need to fill out and attach a Schedule C to your normal 1040 tax return. 

Final Thoughts

At the end of the day, paying yourself as a sole proprietor will depend on your company’s projected profits, your living expenses, and how much you will be paying in taxes. 

It’s also important to stay flexible, and adjust your self-payment strategy as your business grows and evolves. Of course, consulting professionals who can give you sound advice specific to your particular needs will help make sure that your sole proprietorship is a success. 

 

Sources: 

Salary or Draw – How To Pay Yourself As A Business Owner | Quickbooks

Sole Proprietorships | IRS.gov

Paying Yourself | From Startup And Beyond | Entrepreneur

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