How to pay yourself as a sole proprietor

The best part of being the business owner of a sole proprietorship? Getting paid for it! 🤑 

One of the not-so-great parts? Figuring out how to pay yourself as a sole proprietor, since there are certain rules and best practices to follow to ensure you and your business are set up for success. While paying yourself as a sole proprietor can seem complex and overwhelming at first, it’s actually not so tricky once you know the three key steps to follow. That’s where we can help! 

In this article, we’re covering:

• What a sole proprietor is
• How to pay yourself as a sole proprietor in three easy steps, and why it’s important 
• How much you should pay yourself as a sole proprietor
• Taxes for sole proprietorships
• How to manage your money as a sole proprietor
  ‍

Keep reading to learn how to pay yourself like a pro! 

What are sole proprietorships?

A sole proprietor is someone who owns an “unincorporated business” by themselves, according to the Internal Revenue Service (IRS). “Unincorporated business” is just a fancy way of saying you and your business are one in the same, so you’re personally responsible for your business’s activities and liabilities (unfortunately, this includes any debt). 

While your business can operate under a different name than your own, you are ultimately the owner: all profits from your business must go to you, and it’s your responsibility to report them (if your income is over $400). 

Forming a sole proprietorship is one of the simplest ways to start a business, since you don’t need to file any official paperwork with the government (and no paperwork = always a win). 

Major plot twist: this means if you’re currently selling goods or services, but haven’t submitted any formation paperwork with the government, you’re already a sole proprietor!

How to pay yourself as a sole proprietor

You can pay yourself as a sole proprietor in three steps by: setting up a business bank account, transferring money from your business bank account to your personal bank account to pay yourself, and then tracking these transactions. 

Paying yourself as a sole proprietor is super important, because it helps the IRS confirm your business is legit and helps you make smart money decisions.

For instance, if your business is only profitable because you’re not paying yourself, that’s actually not a true sign your business is successful (and you deserve to get paid!). If you’re honest about how your business is performing and tracking the money going in and out of your business, this sets you up to make better business choices. Plus, investors or lenders will actually see it as a red flag if you’re not paying yourself, even if that means you’re making a profit. 

TL;DR—it’s in your best interest to pay yourself as a sole proprietor, so pay attention to the three steps below!

Step 1: Set up a business bank account

The first step is setting up a business bank account so you can keep your business and personal transactions separate. Put all income from your business directly into your business account first. 

This will keep the IRS happy, and keep things nice and organized so that your personal funds don’t get mixed up with your business funds—but more on the importance of a business bank account later. 

Since you don’t need to fill out any fancy paperwork to register as a sole proprietorship, your business name is your own name. So if you aren't using a different name for your business, you can open up a business account in your own name. On that note, if you do want to use a different business name, you'll need to file a DBA (doing business as). 

It’s also best practice to have a dedicated debit or credit card that's just for your business, so you can directly pay all business expenses and have a record of them in one place.

Step 2: Pay yourself

Time for the best part. Once your business bank account is up and running, all you really need to do to get paid is move money from your business account to your personal account. 

One thing to note: when you pay yourself as a sole proprietor, you aren’t actually paying yourself a “salary”—instead, this is called an “owner’s draw,” or simply "a draw." Your pay is the profit your business makes, and you take a ‘draw’ on these profits throughout the year. 

You can do that by sending a transfer, making a direct deposit, withdrawing cash, or—if you’re old school—writing a check. 

Step 3: Track transactions

Next, track these transactions. You can mark transactions to yourself as an "owner's equity" or "disbursement" in your records (more on that later).

When you withdraw money from your business account into your personal account, you are technically withdrawing “profit,” not salary, which means taxes aren’t taken out. Since taxes aren’t withheld when you make a draw, you’ll need to track how much you owe in taxes so you can set aside money. 

This allows you to estimate how much you’ll owe at the end of the year, and make federal and/or state tax payments on a quarterly basis. FYI, if you estimate you’ll be paying more than $1000 in taxes, you’ll probably need to make quarterly payments. 

Do I need a business bank account for my sole proprietorship?

Technically, there’s no legal requirement you need a business bank account for your sole proprietorship. However, it is strongly recommended—for all business owners in general—for a bunch of reasons. 

As a business owner, keeping your business finances and your personal finances separate lets you more accurately track your income and expenses, stay on the pulse of how your business is performing, and make smart projections and decisions. A business bank account also lets you accurately record your business expenses, so you can back up any tax deductions you claim (more on those later!). 

Plus, a business bank account can help you look and feel like the professional business owner you are. For example, seeing that you have a business bank account helps build trust with your clients and vendors. Even better, a business bank account lets you accept credit card payments, unlike a personal bank account—and giving your clients more ways to pay you is a great way to keep growing your business!  

How much do I pay myself as a sole proprietor?

Okay, now you know how to pay yourself as a sole proprietor. But how much should you pay yourself?! 

To know how much you should be paid, you'll need to calculate how much profit your business expects to make, and then determine how often you should draw a paycheck from your business. The key to doing this is by tracking and accurately recording your business’s assets and liabilities. 

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

For example, once you find your business’s profit, you could then divide it by twelve to figure out how much you can pay yourself per month. Or, if you decide you want to make a certain amount per year and have determined that number is realistic based on your business’s profits and expenses, you can divide your desired annual ‘salary’ by twelve. 

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, and paid off any business debts, you can start to increasingly pay yourself what you are worth.

If business is boomin’, you can give yourself a bonus every quarter, or even increase your ‘salary.’ As we mentioned before, just make sure you’re keeping track of your expenses and setting aside some money for tax-time.

In terms of how often you should pay yourself, every two weeks or once a month is the most common. But you’re the boss, so you make the rules. 

When calculating the value and the frequency of your pay, consider your personal goals and your lifestyle. Some people prefer contributing to their savings, while others put that money into traveling or time with friends and family.

What about taxes for sole proprietors?

Sole proprietorships need to pay federal, state, sales, and sometimes local income taxes on their profits. This section is already a lot less fun than the previous one (unless tax forms are just as cool as paying yourself and saving up for a vacation to you—in which case, get excited!), but we promise the tax stuff you need to know about isn’t that terrible and is more simple than other business structures. 

As a sole proprietor, you’ll owe “self-employment taxes,” which include Social Security and Medicare, if you made more than $400 in the tax year. The tax rate is 15.3% in total, but it might be possible to deduct a portion of the tax. The actual amount you have to pay depends on your profit and unique situation. 

If you have employees, you might need to deduct federal and state unemployment taxes from their wages (not your own!), so you’ll need Form 940. 

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. Your business itself is not taxed separately, so your business income and losses get reported on your income tax return, and you’ll get taxed on all profits. 

Here the forms you’ll need to submit to the IRS as a sole proprietor: 

• Schedule C (Form 1040): reports your business income and expenses 
• Schedule SE (Form 1040): reports your self-employment taxes 
  ‍

The IRS recommends most sole proprietors pay estimated taxes on a quarterly basis, so you may also need Form 1040-ES. (Don’t worry about overpaying—you’ll get a refund!) 

Tax deductions for sole proprietors

The next step is one everyone’s a fan of: finding any tax deductions you qualify for! A tax deduction is a business expense you can subtract from your taxable income, which can lower the amount of tax you have to pay. Think of it this way: It’s like you “earned” less money, and therefore have to pay less tax. This is why we were really pushing for you to get a business bank account back there—so you can more easily track your deductible expenses. 

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.

Keeping track of your sole proprietorship finances

While a sole proprietorship is the simplest business structure, you'll still want to make managing your books as easy as possible with…*drum roll*... accounting software! Accounting software helps you easily calculate how much to pay yourself, and how much you owe in taxes. 

One easy option is Wave's accounting software—which was built for business owners like you, not accountants!  

Wave’s accounting software can help you easily keep track of your income and expenses in one neat and tidy place, keeping you in control and in the know of how your business is performing. You can categorize payments to yourself as "owner's equity" or "disbursements" so that you know exactly how much you are paid.

Wave also helps take the stress out of tax season by reliably organizing your income, expenses, payments, and invoices for you so you can focus on the best parts of running your business (which, we’re guessing, doesn’t include bookkeeping). 

Next steps for paying yourself as a sole proprietor

…Aaand we’re done! Now you know:

• How to pay yourself a sole proprietor, and why it’s important 
• How much you should pay yourself 
• How to prepare for tax season 
• Why you need a business bank account, and why you need to track your business transactions
  ‍

This was a lot of information, so if you’re not sure what to do next, we suggest setting up your business bank account and card and connecting to an accounting software first. Remember the key to painlessly paying yourself is to keep your business records organized so you can make informed decisions about how much you should pay yourself, and always be ready for taxes. 

Now get out there and get paid!

‍