Getting paid when you work for yourself is not as straightforward as it might seem.
Sole proprietors must follow these guidelines for paying themselves so they do not get in trouble with the Internal Revenue Service or other US government agencies.
How can you get paid when you started your own business that is an unincorporated company, DBA sole proprietor? It appears simple, right? You sell a product or perform a service and you and get paid. That is how self-employment functions, right?
If only it were that easy. Whenever you’re getting paid for something, the IRS along with a couple other national, state, and local agencies need a bit of it. For taxation purposes, if you are running the company as a sole proprietor as many freelancers, consultants and independent contractors perform, you do not pay yourself a salary and can not deduct your salary as a business expense. Instead, your income in the company is composed of the company gains and those get added to your income tax return.
So how can you work it out when you cannot wait until the end of the year to pay yourself a salary? How can you set things up so that you can pay yourself on a regular basis and be sure that the business expenses are monitored in a manner which makes accurate reporting to the IRS and other agencies simple at the end of the year?
Here is the best way to deal with paying yourself as the business owner and manager.
Am I a Sole Proprietor?
First, you will need to be sure that you know what a sole proprietor is. According to the IRS, “a sole proprietor is somebody who owns and operates an unincorporated business by himself or herself.”
The company may have a name that is different from the given name of the firm/brand (or not – that is up to you). But even when the company has a different name, if you’re the sole owner and have not incorporated or formed an LLC, the company, all of the profits of the company pass through to you and are taxable in your personal income tax forms.
As a sole proprietor (or self-employed person) you will have to pay federal and state income taxes on all of the profits, and you’ll also have to pay a self-employment tax.
Since your “salary” when you’re self-employed is the profits from the company, the self-employment tax is computed on the company profits.
Paying Yourself a Salary
As a sole proprietor, you can pay yourself whenever you want (as the company income allows).
Ideally, you’ll do it on a regular basis. To pay yourself, you write out a check to yourself for the quantity of money you need to withdraw from the company, and describe it as owner’s equity or a disbursement. Then deposit the check in your personal checking or savings accounts.
Remember this is “profit” being pulled, not a salary. So no Social Security or Medicare come from your check. However, you’ll need to pay those taxes (the self-employment taxation), so make sure you put aside money to pay the cost. Once the company is profitable, you are going to be paying these sums quarterly in the kind of estimated taxes, but on your first year of business operation, you might not need to pay anything until you file your yearly return.
If you have expenses which will ultimately be shared between private and business accounts, (i.e., the cost of Internet usage, if your home-based company uses the same online connection the household does) those prices will not get recorded in your accounting program. You’ll calculate them at the end of the year when you prepare your taxes and have a deduction for them on the Home Office Deduction tax form.
Separate Business Money from Personal
As a company owner, you will have to keep accurate records of your income and business expenses. Doing that is going to be extremely difficult if you put all of your company profits into the same bank account you use for your individual and family expenditures.
Comingling business funds with your personal monies may also make it more challenging to establish expenses were strictly for the company if they seem like personal expenses.
To keep things easy for yourself, your accountant, and the IRS open a business checking account for your company.
If you are not using a company name, open the accounts in your own name, but make certain to use it just for the company. If you’re using a business name (i.e., Susan’s Salon), the lender will take a copy of a DBA certification (certificate saying you are doing business under a fictitious name) or a business license or both. (Check with your lender to learn what they will need. Some banks may require a DBA certification for a company even if the company “name” is the name.)
Utilize this business checking account to deposit all income from the company. Checks, ACH deposits, credit card sales receipts, and any additional income should all have deposited into this account.
Pay all of the company bills from this account also. Your bank statements, together with documents you keep about spending and income, will provide you and your accountant a clear picture of just how much the company earned, how much is invested and what its gains are. (If there is a company name on the accounts, it will also help your organization look more established to clients.)
If your organization is home-based, get another phone line for your company. You can deduct the cost of the company phone from your taxes. Plus you can then answer all calls with your company name and sound more professional. Get an 1- 800 number for your business
If you are charging to a credit card any company expenses, get another charge card to be used by the company. The credit card will probably be issued in your name, not the business’ name, or if the company name is on the card, your name will also be imprinted on the card.
Use this credit card solely to buy products or services for your business. Don’t make any personal purchases with the card. This method assures that you will know that everything charged to this card is for the enterprise.
Use an accounting program, I recommend Quickbooks Online as the best accounting, to list all of the deposits and withdrawals from the company checking accounts. Use the accounting program to describe the nature of the expenses as you cover them. (i.e., site hosting, office supplies, accountant’s fees, etc.) Doing this will allow you to see at any moment what your gain (or loss) is.
Tracking expenses such as this on your accounting program will also make it far easier at the end of the year to categorize your spending for taxation purposes. Additionally, it will help you budget for the next year and examine your spending patterns.