Wednesday, May 25, 2022
Cash FlowHow Sole Proprietors Should Pay Themselves

How Sole Proprietors Should Pay Themselves

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Business owners that personally own their business are identified as sole proprietors by the IRS, even if they do not have formal incorporation. Most businesses in the United States, about 70% of them, fall into this category. When it comes time to get paid from your business, the process is quite simple.

Keep Records

In any business, being able to know how much money comes in or goes out is very important. Of course, the IRS wants to know this, too, and having good records will simplify things when it comes tax time each year.

A Sole Proprietor Is Not an Employee

The IRS looks at your business and its income and expenses as your personal income. It sees no difference between the two. For this reason, you are not paid as an employee of your business. All profit and expenses are considered your own.

You Can Get Paid by a Draw

When you need to be paid from your business, all that is necessary is to write yourself a check from your business account. This enables you to keep good records and know where each business dollar goes. Unless you have chosen to limit how much you can get per check, such as you would likely do in the early stages of a business, you are free to draw what you want out of your business profits.

Before taking that paycheck, you should consider how well your company is doing and decide how much you should reinvest into the company. If profits are small, some money should be kept in the account for future bills. If the business is doing well, you may want to save money to expand later, rather than taking a larger paycheck.

Getting Paid by Salary Is Another Choice

When you start the business, or even later, you can decide how you want to be paid. You can also change it at any time since you are the sole owner. You can also choose to be paid a salary and take out so much each month. If the business is doing well, this can give you a predictable income, helping to remove some stress that may come at times with a small business.

You can also give yourself a raise at any time, or even use a combination of methods. You can choose to set certain business goals, for instance, and when those goals are reached, give yourself a bonus! This can help your business grow even faster when you challenge yourself.

It Is All Reported on a Schedule C

When it comes tax time for sole proprietors, your business information is all reported on a Schedule C with your 1040 tax forms. Your paychecks are not counted separately as they would be on a W-2. Instead, you will pay taxes on the net profit reported on your Schedule C. Taking out a draw for your pay does not reduce your tax obligation. If you had a $25,000 net profit for the tax year, this figure will determine how much you will pay in taxes.

Your carefully recorded business expenses are subtracted from this amount, which will lower the amount of taxes you owe. Since there is not an employer taking out taxes for Social Security and Medicare, you will pay for these expenses yourself. These figures are calculated into your tax forms as a self-employment tax. Quarterly payments are expected by the IRS for these amounts.

 

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