Can You Pay Yourself A Wage If Self-employed?

Can You Pay Yourself A Wage If Self-employed?

Getting paid when you work for yourself isn’t as simple as it may seem. Sole proprietors should follow these guidelines for paying themselves in a way they don’t get in trouble with the ATO or other government agencies.

Suppose you’re a sole proprietor, or a partner in a partnership. In that case, you need to think carefully about how you take money out of your business entity.

For many, the chance to set your salary sounds like a dream come true. But small business owners know the reality is a little more complicated.

You should only pay yourself out of your profits – not your revenue. When you see money coming into your business, don’t assume you can pay yourself a big slice of that. Before you take your cut, you also need to take account of things like taxes, payroll, fixed costs and overheads.

Good accounting software will help you work out how much you can afford to pay yourself. It will let you keep track of all expenses and calculate profit rather than revenue or turnover. It will also help identify areas you can make tax deductions.

Setting your salary will depend on your location, your industry, your profits, and how much you want to earn. But there are a few things to think about that can help you land on a reasonable figure.

It’s an age-old problem that faces every entrepreneur planning their business: What do I pay myself? That pay stub is a reflection of all the hard work it took to bring your business to life. And when you get to enjoy that moment, it can be a fantastic thing to experience. 

Small business owners need cash to breathe life into their companies. From starting and growing a business to paying, it’s hard to keep up with an ever-growing list of expenses. And you need money for yourself.

Consider The Legal Structure Of Your Business.

How much you can pay yourself, and when, might be restricted by the legal structure of the business you run.

For example, if you’re a sole proprietor, you’re usually free to pay yourself whatever and whenever you like. That’s partly because you’re not accountable to shareholders or stockholders.

But other types of business, like incorporated businesses, usually have the business owner on the payroll. They would receive wages regularly, just like any other employee.

However, the rules do vary from country to country, so check with your accountant before you decide anything. Be sure to record all transactions in your accounting software so you have an audit trail too. Do this just in case the tax office decides to investigate your payments to yourself.

How to Pay Yourself From Your Business

Some business owners pay themselves a salary, while others take an owner’s draw to compensate themselves. You may decide to use one of these methods, or a combination of both.

Don’t just dip into your business funds as and when you need to. Set up payments for you and your employees (it may be weekly or monthly) in your payroll software, and stick to them.

Build that into your business plan right from the start, perhaps with a rising salary as your business grows. That way you’ll get used to the amount of money you receive and won’t have to worry about taking out occasional large lump sums.

This will also look better to your employees. Regular small payments will be more acceptable to them than random large lump-sum withdrawals from the business. They will also look more acceptable to the government, too. If you take out big sums of money at irregular times, it may raise eyebrows at the tax office or lead to an audit of your company.

 As a sole proprietor, you can pay yourself whenever you want (and the business income allows). Ideally, you’ll do this on a regular basis. When you do pay yourself, you just write out a check to yourself for the amount of money you want to withdraw from the business and characterize it as owner’s equity or a disbursement. Then deposit the check in your personal checking or savings account.

Remember this is “profit” being withdrawn, not a salary. Therefore, no income taxes, Social Security or Medicare comes out of your check. But you will have to pay all those taxes when you file your personal tax return, so remember to set aside money to cover the expense. Once the business is profitable, you’ll be paying these amounts quarterly in the form of estimated taxes, but in your first year of business operation, you may not have to pay anything until you file your annual return.

If you have expenses that will ultimately be shared between personal and business accounts, (i.e., the cost of Internet use, if your home-based business uses the same Internet connection the family does) those costs won’t get recorded in your accounting program. You’ll calculate them at the end of the year when you prepare your taxes and take a deduction for them on the Home Office Deduction tax form.

Don’t Undervalue Yourself.

If you’re just starting a business, you might not turn a profit during your first year. Of course, this doesn’t mean you shouldn’t pay yourself.

There’s no point in being a complete miser with your company’s money if it causes you financial and emotional problems. Personal money issues are a big cause of stress, and if you’re stressed, then you won’t make good business decisions.

Undervaluing your time and the work you’re doing can harm your productivity and your business, so you should pay yourself enough to live comfortably without worrying. Take out what you need to avoid causing problems for your business and your personal life.

Once you’ve determined the right type, your next job is to calculate how much to give yourself. Wait, I can’t just pick any number? Well, not exactly. You want to pay yourself an amount that ties to your duties, and also sets your business up for long-term success. 

When you own a business, paying yourself is different from receiving paychecks as an employee. These are some questions you might have about payments:

  • Can I take money out of my business’s income, or do I receive a salary?
  • How do taxes work with my paychecks?
  • Do I choose how much to pay myself?

In order to answer these questions, you need to look at factors such as your business entity, profits, and how much you think is a fair rate for your work.

The first recommendation is that you set up a business bank account so that you can keep your business and personal transactions separate. If you aren’t using a different name for your business, you can open up a business account in your own name. If you want to use a different business name, you’ll need to file a DBA (doing business as).

Put all checks, sales, and all income from the business directly into that business account first. It’s best to practise to have a dedicated credit card or charge card that’s just for the business so that you can pay all business expenses directly and have them in one place.

Once your accounts are set up and running, all you really need to do to get paid is to transfer money from your business account to your personal account. Instead of receiving a salary, this is called “a draw”. You effectively write a check to yourself. You can do that by writing a check, sending a transfer, or making a direct deposit.

Next, track it. If you’re using accounting software, you can mark transactions to yourself as an “owner’s equity” or “disbursement” (more on that later).

 How do you pay yourself when you are self-employed and haven’t incorporated your business or formed an LLC? It ought to be simple, right? You sell or do something and get paid. That’s how self-employment works, for freelancers, consultants, independent contractors and other self-employed, right?

If only it were that simple. When you are self-employed, you are running a business and have to pay taxes on your income and abide by certain rules. For tax purposes, if you haven’t incorporated or formed an LLC, the form of business you are operating under is called a sole proprietorship. 

As a sole proprietor, you don’t pay yourself a salary, and you cannot deduct your salary as a business expense. Technically, your “pay” is the profit (sales minus expenses) the business makes at the end of the year. You can hire other employees and pay them a salary. You just can’t pay yourself that way.

You don’t have to wait until the end of the year to withdraw your profits, though. To pay yourself when you need money during the year, you take what’s called a draw on the profits. Taking a draw simply means taking money from the business account and giving it to yourself. You could take out cash or write yourself a check. 

Determine Your Business Type

Your business entity is where it all begins. In fact, it’s the foundation for the entire payroll process and will help point you to the payment style that’s right for you.

Already know your entity? Bravo, scroll down to the next step.

If not, this overview will help you get a good idea of what options are out there. Before finalizing your decision, remember to schedule some time with your accountant to help explain the ins and outs of each kind.

ou can do it once a week, once a month, or randomly, as needed.

Pay Yourself Enough To Get By.

At least during startup, until you are operating in the black. The argument here is to minimize your overhead in order to decrease the amount of capital required to make your business a success. Also, by reducing your overhead, your net loss will decrease, or your net profit will increase, providing the business with lean operating requirements until it is well established.

Pick a Payroll Schedule

If your business has at least one employee (including yourself!), you need to think about how often you want to pay yourself. In the U.S., the most popular payroll schedules are twice a month, every two weeks, and weekly.

Most states require that you follow a basic calendar, so find where your state falls on this chart from the Department of Labor. The basic rule is that you can always pay yourself more often, but never less than your state’s particular schedule.

Separate Business Accounts from Personal Accounts

As a business owner, you’ll need to keep accurate records of your income and business expenses. Doing that will be extremely difficult if you put all your business earnings into the same account you use for personal expenses. Commingling business funds with your personal account may also make it more difficult to prove expenses were strictly for business if they look like personal expenses.

To keep things simple for yourself, your accountant, and the ATO, open a checking account for the business. If you aren’t using a business name, open the account in your own name, but be sure to use it only for the business. Suppose you are using a business name (i.e., Joe’s Clam House). In that case, the bank will require a copy of a DBA certificate (certificate saying you’re doing business under a fictitious name) or a business license or both. (Check with your bank to find out what they’ll need. Some banks may require a DBA certificate for a business even if the business “name” is your name.)

Use this business account to deposit all income from the business. Checks, ACH deposits, credit card sales receipts, and any other income should all get deposited into this account. Pay all the business bills from this account as well. Your bank statements, along with records you keep about income and spending, will give you and your accountant a clear picture of how much the business earned, how much is spent and what its profits are. (If there’s a business name on the account, it will also help your business look more established to customers.)

If your business is home-based, get a separate phone line for your business. You’ll be able to deduct the entire cost of the business phone – plus you can then answer all calls with your business name so you sound more professional.

How Much Do I Pay Myself?

To know how much you should be paid, you’ll need to calculate how much profit your business expects to make, and then how often you should draw a paycheck from the business.

If you’ve already set up a business bank account and card, then it’s easy to log in to your accounting software (going through your bank is possible), to calculate the net of your sales minus your expenses. Once you know what’s left, you can calculate how much to pay yourself.

In terms of how often you do so, every two weeks or once a month is the most common. When calculating the value and the frequency of your pay, consider your personal goals and your lifestyle. Some people prefer contributing on savings, while others focus on travelling or time with friends and family as priority.

At the start, you could pay yourself the bare minimum, so that your business can break even as soon as possible (considering the costs associated with starting a new business). Once you’ve broken even, you can start to pay yourself what you are worth increasingly.

If you find that business is doing really well, you can give yourself a bonus every quarter, or even increase your salary. Just make sure you’re keeping track of your expenses and setting aside some money for tax-time.

Don’t Forget Deductions, Expenses And Benefits

Leaving aside wages, there are some great financial benefits to running your own business. Medical insurance and 401(k) contributions are just two types of scheme to consider. They can make a big difference to your personal financial situation, and they’re legitimate business benefits.

Here are some examples of expenses that can be offset against the tax your company pays:

  • Car expenses (business mileage of your car)
  • Mortgage interest payments (if you work from your home)
  • Capital equipment expenditure (such as new computers).

You’re not usually allowed to claim expenses in the “personal, living or family expense” category. But you can claim for the business use portion of an item. This might mean you get to drive a new car in your personal life at a reduced overall cost. When in doubt, check with your accountant to find out what will work for you.

Pay Yourself What You Deserve.

Ultimately the amount you pay yourself will depend on the success of your business. The more money your business brings in, the higher the salary you could reasonably be expected to draw from it.

It makes sense not to get carried away and pay yourself too much, for reasons described. But if your company is profitable, there’s no reason why you shouldn’t reward yourself for that success.

Build that into your business plan so you have an accurate portrayal of how much capital you will need in order to finance your business. By paying yourself what you are worth, you aren’t painting an artificial portrait of the business that will change once you reach the black–operating costs will remain the same.

So how do you know what is enough to get by and what you are worth? You have to do some planning and simple mathematics, and then budget that amount into your income and cash-flow projections so that you know how much operating capital you will require during the formative stages of your company’s development.

What happens when you reach break-even and grow beyond that point? There are many factors that go into the equation, such as the legal form of operation and tax requirements. You need to balance your needs against what you feel you are worth, what you need to get by, what the business will be able to sustain, and how your income, as well as the business, will be taxed.

When Not To Pay Yourself

If your business is going through a tough time financially, it’s usually not a good idea to take any money out of your business for personal use.

You should avoid taking any money if your employees haven’t been paid. It doesn’t look good, and would seriously affect their morale if you did.

When you owe a lot of money, it’s also wise to refrain from paying yourself a large amount. Creditors are unlikely to be impressed if you’re still taking home a large pay packet while their invoices or loans remain unpaid.

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