How to Pay Yourself as a Sole Proprietor
Navigate the distinct financial landscape of sole proprietorship. Understand how to properly compensate yourself while meeting all business obligations.
A sole proprietorship is a business structure where an individual owns and operates the business. There is no legal separation between the owner and the business itself, meaning all business assets and liabilities are considered personal. This differs significantly from being an employee who receives a regular salary or wages. The way a sole proprietor “pays themselves” is unique due to this lack of legal distinction.
Separating Business and Personal Finances
Maintaining distinct financial identities for a sole proprietorship and its owner is important, even though they are legally the same entity. This separation is a foundational step for accurate financial management. It provides clarity for tracking income and expenses, simplifying tax preparation. It also helps avoid commingling funds, which can create confusion and make it difficult to assess business performance.
Achieving this separation involves opening dedicated business bank accounts and credit cards for business income and expenses. Within an accounting system, an “owner’s equity” account tracks the owner’s investments into the business and withdrawals from it. This account provides a clear record of the financial relationship between the owner and the business.
A sole proprietor does not draw a “salary” or “wages” like an employee. Instead, money taken from the business for personal use is called “owner’s draws” or “owner’s withdrawals.” These draws are movements of capital from the business to the owner, not a business expense. Understanding this distinction is fundamental to managing sole proprietorship finances.
Understanding Self-Employment Taxes
Self-employment tax is for self-employed individuals, covering contributions to Social Security and Medicare. This tax replaces Federal Insurance Contributions Act (FICA) taxes withheld from an employee’s paycheck. Sole proprietors pay both the employer and employee portions of these taxes.
The self-employment tax rate is 15.3% on net earnings from self-employment: 12.4% for Social Security and 2.9% for Medicare. The Social Security portion applies to net earnings up to $176,100 for 2025. The Medicare portion has no wage base limit, applying to all net earnings.
Self-employment tax is calculated on 92.35% of net earnings. For example, if a sole proprietor has $100,000 in net earnings, the tax is calculated on $92,350. This calculation accounts for a deduction for one-half of the self-employment tax paid, which is also deductible from gross income for income tax purposes.
Sole proprietors must pay estimated taxes quarterly to cover self-employment and income tax liabilities. This aligns with the U.S. pay-as-you-go tax system and helps avoid underpayment penalties. Payments can be made electronically through IRS Direct Pay, the Electronic Federal Tax Payment System (EFTPS), or by mail using Form 1040-ES.
Recording Owner’s Draws
When a sole proprietor needs personal funds, they execute an owner’s draw. This can be an electronic transfer from the business bank account to a personal account, or by writing a check. These transfers are for personal funds and are not business expenses.
Documenting every owner’s draw is important for accurate financial tracking. Each record should include the date, amount, and a clear description like “owner’s draw for personal expenses.” This detail helps maintain clear financial records.
These transactions are recorded in an accounting system, often within an “owner’s equity” account. Accounting software, a spreadsheet, or a ledger can track these withdrawals. Proper recording generates accurate financial statements, simplifies tax returns, and provides a clear picture of the business’s true profitability. Owner’s draws are not tax-deductible business expenses.