How to Pay Yourself as a Sole Proprietor

all right today we're going to talk about how to pay yourself as a sole proprietor if you are a sole proprietor or in other words you are doing business and have not formally incorporated into an llc corporation or a partnership then you are a sole proprietor my friend and guess what today's episode is all about you a lot of people on our channel have been asking for some help with this so if you are a sole proprietor go ahead and help me out by liking this video and commenting below as we get this sole proprietor party started [Music] alright welcome to the channel everyone my name is sherman and i am a licensed cpa here at life accounting where we help you save on taxes and boost profits and if you've never seen an episode from us before then go ahead and hit that subscribe button because i promise you there's not another channel like us that puts out quality content to help you with things like this so today i'm going to walk you through step by step on how to pay yourself as a sole proprietor specifically i'm going to explain who is a sole proprietor how sole proprietors pay taxes and how much you should be paying yourself as a sole proprietor so if you stick to the end i'm also going to give you my framework for how sole proprietors should be paid all right so what is a sole proprietor a sole proprietor is simply someone who owns an unincorporated business so if you earn money and you are not employed and haven't registered as an entity with your state then you are a sole proprietor for example let's say you wake up and decide to cut your neighbor's yard in exchange for money the moment you get paid you are technically a sole proprietor and if you're wondering is that money taxable well you bet it is according to the irs all income received is considered taxable so then let's talk about how sole proprietors pay taxes for tax purposes sole proprietors are considered what is called disregarded entities all this means is that you do not have to file a business tax return when you file your taxes instead you will file what is called a schedule c when you file your personal tax return this is good news because business tax returns are generally more expensive and have to be filed a little bit earlier normally the deadline for filing a business return is march 15 and personal deadlines are april 15th so as a sole proprietor you get an extra month to file your taxes but what kind of taxes do you have to pay as a sole proprietor well generally the main taxes are federal income taxes state taxes and the big fat ugly 15.3 percent self-employment tax on your income by the way you can limit your self-employment tax exposure by incorporating into an s corporation but for more information on that be sure to subscribe and check out our channel because we have a video on that now of course you pay these taxes on your income but what's confusing is what exactly is income when you're operating as a sole proprietor a lot of people i talked to get this wrong so please allow me to explain your income is simply the amount of money your business earns minus all tax deductible expenses or deductions you can take generally it is your net profits from the business you're operating but many people get this confused with the money they pay themselves from their business the reason why this is wrong is because you are not taxed on the money you take out of your sole proprietorship so if your business earned 100 000 in profits and you did not take a penny out of your business then guess what you're going to have to pay taxes on the full 100 000 well then you might think that the money you pay yourself from your business then is tax deductible so if you paid yourself fifty thousand dollars out of the one hundred thousand dollars then that would mean you should be only taxed on the remaining fifty thousand dollars right wrong the money you pay yourself is not tax deductible you do not subtract the money you pay yourself from your business from the business's income the reason why is because you are not an employee of the business therefore in the eyes of the irs all the money the business makes is yours you are also not a 1099 contractor in your business your customers might issue you a 1099 but that just means you are a vendor of their business they're just writing you off as an expense to their business but you are not an expense in your own business so when you file your taxes you cannot deduct what you pay yourself therefore the transfers you make between yourself and the business are completely irrelevant for tax purposes so again business revenue minus tax deductible expenses equals your taxable income and then you're going to pay taxes on that taxable income so that's the tax side of how to pay yourself as a sole proprietor in a nutshell you earn money you deduct your expenses and you're taxed on the rest now the only other tax piece here is that technically you should be paying your estimated taxes on a quarterly basis so let's say you owe ten thousand dollars in taxes last year you'd simply divide this amount by four and pay twenty five hundred each quarter to the irs as your quarterly estimated taxes as long as you pay 100 of what you paid last year in taxes on a quarterly basis then you don't have to worry about paying any penalties or you can also pay 90 of what you expect your tax liability will be this year and then if you do that then you're also safe but to me that's a little bit more tedious to keep up with as numbers fluctuate so i prefer just paying 100 of my tax liability last year on a quarterly basis however if you expect to earn much less in this tax year than you did in a prior tax year then it might make sense to pay 90 of what you think you will owe this year that way you don't have to put yourself in a position where you're giving the irs way too much money so as long as you understand that side of things then you are pretty much covered on the tax side of a sole proprietorship all right now let's discuss how to pay yourself in a sole proprietorship here are the steps that you should take all right step number one operate out of a business bank account now this is business 101 you do not want to commingle your business funds with your personal funds it's going to make bookkeeping and finding tax deductions a nightmare furthermore it can also complicate things if you get audited by the irs somehow they're going to have to make sense of the things you claimed for tax purposes and if this is not clear then you might get into some serious trouble all right step two transfer money from your business bank account to your personal account you can write yourself a check you can wire funds to yourself or you can just go to the bank and take out cash but remember the money you pay yourself is your business your taxes are going to be based on the business overall profits not how much you pay yourself but wait a minute does this mean you should take all the business profits to pay yourself absolutely not so let's move on to step number three pay yourself but don't hurt your business a lot of sole proprietors make the mistake of paying themselves way too much sometimes they don't leave enough money in their business and then they find themselves going into debt to fund their operations or just going out of business all together and a lot of times it's because they're taking too much money out of their business so here's what you need to do you need to think about cash like fuel if you run out of cash you're on e the game is over you want to keep enough fuel in your business so you can make it to where you're trying to go with that said here is my framework to make sure this happens and it doesn't involve creating seven different bank accounts or some of this other stuff that i'm seeing out here all right so rule number one leave three months of operating expenses in your business now this is your safety net if you always leave three months of operating expenses in your business then you will be able to stomach any sudden or unexpected expenses that may come up alright rule number two put aside money to pay your estimated taxes your taxes are not optional so don't be that person at tax time who does not have the money to pay their tax bill because you're driving it or because you spent it all on a fancy vacation put yourself on a schedule to pay your estimated taxes quarterly and also leave that amount in your business rule number three put aside money to reinvest in your business if your goal is to grow your business then the chances are that it's probably going to cost you some money to do this especially when you want to grow your business very quickly so whether that's upgrading your equipment hiring employees to help you or developing some type of software or process be sure to leave this exact dollar amount in your business bank account and rule number four everyone's favorite rule here pay yourself everything that is left look if you have money set aside for the first three things then go ahead and rob the bank of everything that is left over it's your money you earned it and most importantly you can have peace of mind and not worrying about uncle sam or your ability to pay your bills on time but i want to hear from you what do you think about this let me know how you pay yourselves and your sole proprietorship in the comments below thanks for watching everyone and i will see you in the next episode

Channel: LYFE Accounting

Views: 51,219

Keywords: pay yourself

Id: 1XrzwsCGycM

Length: 10min 32sec (632 seconds)

Published: Tue Jun 22 2021