Understanding how you pay yourself as a sole proprietorship can be confusing. When you go into business for yourself, you rarely worry about the structure of your business if you are the only one running it. While this may sound simple, it can spell financial disaster for you at the end of the year if you don’t have enough money to cover all of your income tax obligations. It’s important to understand how sole proprietorships work and what you need to do to protect yourself at the end of the year.
Sole Proprietorships
A sole proprietorship is a type of business structure that is owned and managed by one, single person. The business has no other employees on the payroll. All of the business’s income and expenses are dealt with by the owner who basically pays him or herself from the profits of the business. The sole proprietor of the business is responsible for paying the taxes at the end of the year. They are responsible for any self-employment tax that is due as well as any state or local income taxes as well.
Separate Bank Accounts for Personal and Business Finances
When dealing with a sole proprietorship, the owner must maintain separate bank accounts for themselves as well as the business. If the accounts are not separate, it will be difficult to determine business expenses from personal expenses and may not show an accurate representation of the financial health of the business. You can find accounting programs online to keep accurate records of the transactions (both income and expense) for the business.
Salary vs Profit
If you pay yourself a salary, you will take all of your local, state, and federal taxes out of the amount you receive before you write the check. If you are simply taking your money from the profits of the business, you will be responsible to pay your own self-employment taxes out of that amount. When you cash your check, remember to set aside a portion of the total amount for taxes. In most cases, 25% should be enough to cover your taxable portion. If you aren’t sure how much you will owe, you can always talk to an accountant to find out how much you should set aside.
Maintain Accurate Records for Tax Time
Always maintain accurate records for both your personal as well as your business accounts. This will be extremely beneficial at tax time and will give you an accurate representation of your business income as well as its debts. Many people keep a paper journal as well as their receipts and then enter everything into a digital program at the end of the day. There are also ways to maintain all of your records in a digital format. Having a sole proprietorship doesn’t have to be confusing or hard to manage. As long as you keep everything from your business separate from your personal finances, it will be easy to determine what your profit margin is and how much you are earning each pay period. Working capital is a good way to create a cushion that ensures you still get paid even if your business is going through a slow period.
