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How to pay yourself as a sole proprietor

Dec 9, 2019 | 4 minutes read | Entrepreneurship

The simplest way to start a business is one where you and the company are one and the same. This is called a "sole proprietorship", and it makes getting paid very easy, as long as you follow a few simple steps.

In this article, we’ll be covering:

  1. What is a sole proprietorship?
  2. Pros and cons of a sole proprietorship
  3. How do I get paid?
  4. How much do I pay myself?
  5. What does that mean for taxes?
  6. How to keep track of your finances

What is a sole proprietorship?

According to the IRS, "a sole proprietor is someone who owns an unincorporated business by themselves." The business can operate - or trade - under a different name than your own, but ultimately you are the owner: all profits from the business must go to you, and you have an obligation to report them.

Pros and cons of a sole proprietorship

There are a few different pros and cons to consider (we summarize this great list from Fundera).

Pros

Cons

  • Start right away. You don't need to incorporate, but remember that you may need to have a business licence. Here is a good guide on business licences.
  • No lawyer needed. It's easy to make it happen, legally.
  • Simple taxes. Only one form!
  • Liability. The one major advantage of a corporation is that it's a buffer between you and a client. It is possible as a sole proprietorship that you can personally be chased down for your business debts.
  • More work. You may have to do more as a business owner, and handle more responsibilities.
  • More taxes. You have to pay both personal and self-employment taxes.

Ultimately, you should make a decision about your business structure based on what you hope to do. If it's a small business or even a self-employed practice, then a sole proprietorship could be a good option. But if you want to grow something big or work in an industry that often deals with legal issues, it may be worth putting time into setting up an LLC/LLP/or Corporation. The Balance goes deeper into different business structures.

How do I pay myself as a proprietorship?

Now, for the good part - getting paid!

The first recommendation is that you set up a business bank account, so that you can keep your business and personal transactions separate. If you aren't using a different name for your business, you can open up a business account in your own name. If you want to use a different business name, you'll need to file a DBA (doing business as).

Put all checks, sales, and all income from the business directly into that business account first. It’s best practise to have a dedicated credit card or charge card that's just for the business, so that you can pay all business expenses directly and have them in one place.

Once your accounts are set up and running, all you really need to do to get paid is transfer money from your business account to your personal account. Instead of receiving a salary, this is called "a draw". You effectively write a check to yourself. You can do that by writing a check, sending a transfer, or making a direct deposit.

Next, track it. If you're using accounting software, you can mark transactions to yourself as an "owner's equity" or "disbursement" (more on that later).

How much do I pay myself?

To know how much you should be paid, you'll need to calculate how much profit your business expects to make, and then how often you should draw a paycheck from the business.

If you've already set up a business bank account and card, then it’s easy to log in to your accounting software (going through your bank is possible), to calculate the net of your sales minus your expenses. Once you know what's left, you can calculate how much to pay yourself.

In terms of how often you do so, every two weeks or once a month is the most common. When calculating the value and the frequency of your pay, consider your personal goals and your lifestyle. Some people prefer contributing on savings, while others focus on travelling or time with friends and family as priority.

At the start, you could pay yourself the bare minimum, so that your business can break even as soon as possible (considering the costs associated with starting a new business). Once you've broken even, you can start to increasingly pay yourself what you are worth.

If you find that business is doing really well, you can give yourself a bonus every quarter, or even increase your salary. Just make sure you’re keeping track of your expenses and setting aside some money for tax-time.

What does this mean for taxes?

Filing taxes as a sole proprietor is simple.

When you do a draw, you don't need to pay federal or state income taxes, or social security and medicare taxes. All you need to do is file a Form 1040 Schedule C to the IRS once a year.

To calculate your deduction, add up all your business expenses for various categories, like advertising, car expenses, or meals. There are quite a few expenses you can deduct, so make sure you review your spend throughout the year to see what the IRS considers deductible.

And of course, you'll still need to file your own personal income tax return, but the number for that is simple - it's the remaining business profit, after you've paid out your taxes and deducted your business expenses.

How to keep track of your finances

While a sole proprietorship is the simplest business structure, you'll still want to make managing your books as easy as possible with accounting software like Wave.

Wave can help you easily keep track of your expenses by automatically pulling in your bank and card statements. Also, you can categorize payments to yourself as "owner's equity" or "disbursements" so that you know exactly how much you are paid each year.

Accounting software lets you easily calculate how much to pay yourself, and how much you owe in taxes. Software like Wave’s lets you manage your income and expenses, and keeps things simple. You should have everything about the health and success of your business right at your fingertips, so you can stay focused on running the company and living your life.

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