How to Pay Yourself as a Sole Proprietor: A Comprehensive Guide

Hi, I'm attorney Elizabeth Potts Weinstein. Today, we're diving into the essential steps for paying yourself as a sole proprietor. If you own a business solely under your name and haven’t formed an LLC or corporation, you're automatically a sole proprietor. You can file for a DBA (Doing Business As) or an FBN (Fictitious Business Name) if you want to operate under a business name different from your own, but legally, it's still just you.

Why You Shouldn't Mix Personal and Business Finances

As a sole proprietor, you might think it's easier to deposit all business income into your personal checking account and spend from there. However, this approach is problematic for several reasons:

1. Tax Obligations: You need to set aside money for income taxes and self-employment taxes.
2. Business Expenses: You must reserve funds for both recurring and occasional business expenses.
3. Financial Tracking: Without clear separation, it's challenging to track your business’s profitability and make informed decisions.

Steps to Effectively Pay Yourself as a Sole Proprietor

1. Open a Separate Business Checking Account

   • Although not legally required, having a dedicated business account simplifies financial tracking. All business income should go into this account, and all expenses should be paid from it. Then, you can transfer funds from your business account to your personal account to pay yourself. This separation helps you track income, expenses, and personal withdrawals accurately.

2. Use Separate Payment Processors

   • Consider having separate accounts for payment processors like PayPal, Venmo, Stripe, or Square. For instance, use a business-specific Venmo and PayPal account to comply with their terms of service and ensure better financial tracking. Regularly transfer funds from these accounts to your business checking account as they are not insured like bank accounts.

3. Obtain a Business Credit Card

   • Using a business credit card for expenses can simplify expense tracking and offer better protection compared to a debit card. Many sole proprietors start with personal credit cards exclusively for business use, but it's beneficial to get a dedicated business credit card if possible. This helps segregate business and personal expenses, making it easier to manage finances and disputes.

4. Set a Regular Payment Schedule

   • Establishing a regular payment schedule for yourself (weekly, bi-weekly, monthly) helps maintain consistent cash flow. Even if the amounts vary, having a schedule ensures you regularly assess your business’s financial health. This practice is particularly useful if you transition to an S Corporation, where formal paychecks on a set schedule are required.

5. Track Business Expenses Diligently

   • Maintain a detailed log or spreadsheet of your regular business expenses, both monthly and annual. This includes recurring costs like web hosting and periodic expenses like insurance premiums. Understanding your overhead helps you determine how much of your income is available for personal use after covering these costs.

6. Set Aside Money for Taxes

   • As a sole proprietor, you’re responsible for income tax and self-employment tax. While the self-employment tax rate is currently 15.3%, your income tax rate varies based on your total earnings and deductions. Regularly set aside a portion of your income for taxes, possibly in a separate savings account, to avoid financial strain during tax season.

Example Calculation Let’s say you receive a $1,000 payment from a client. You might allocate $500 for business expenses, set aside 30% ($150) for taxes, and pay yourself the remaining $350. Adjust these allocations as necessary based on your expenses and tax rate.

Final Tips Keeping business finances separate from personal finances not only simplifies tax preparation but also provides a clearer picture of your business’s financial health. This discipline will be invaluable if you decide to incorporate your business in the future.