Running your own business as a sole proprietor comes with freedom, flexibility, and full control. But when it comes to paying yourself and handling taxes, things can get complicated.
Unlike traditional employees, you don’t get a paycheck with taxes automatically withheld. Instead, you are responsible for setting aside taxes, paying yourself the right way, and making sure you stay compliant with the IRS. This guide will walk you through how to pay yourself as a sole proprietor, how taxes work, and what you need to do to stay compliant.
How Do Sole Proprietors Pay Themselves?
As a sole proprietor, you and your business are legally the same entity. That means there is no formal payroll—you simply transfer money from your business account to your personal account.
This is called an owner’s draw. Unlike a regular salary, an owner’s draw isn’t taxed when you take it. Instead, you pay taxes on your net business profit at the end of the year.
How to Pay Yourself the Right Way
- Open a business bank account to keep personal and business finances separate.
- Track your profits to know how much money your business is making after expenses.
- Transfer money as needed from your business account to your personal account.
For example, if your business makes $5,000 per month after expenses, you can transfer $3,500 to your personal account and keep $1,500 in the business for taxes and future expenses.
How Sole Proprietors Pay Taxes
Unlike employees who have taxes automatically withheld from their paychecks, sole proprietors must handle their own tax payments.
- Self-Employment Tax – Covers Social Security and Medicare (15.3 percent).
- Income Tax – Based on your total earnings after expenses.
- Quarterly Estimated Taxes – Must be paid throughout the year (April, June, September, January).
Breaking Down the Self-Employment Tax (15.3 Percent)
Since you don’t have an employer covering half of Social Security and Medicare, you must pay the full amount yourself.
- 12.4% for Social Security
- 2.9% for Medicare
This applies only to your net profit (income minus expenses).
For example, if your business earns $50,000 after expenses, your self-employment tax would be $7,650 (15.3 percent).
How to Calculate and Pay Your Taxes
- Estimate your taxes using last year’s tax return or an online calculator.
- Set aside 25-30 percent of income to cover federal, state, and self-employment taxes.
- Pay quarterly taxes using IRS Form 1040-ES and submit payments online.
If your estimated annual taxes are $12,000, you will pay $3,000 each quarter in April, June, September, and January.
How to Lower Your Tax Bill as a Sole Proprietor
The best way to reduce your tax burden is to take advantage of deductions.
Top Tax Deductions for Sole Proprietors
- Home office deduction if you work from home
- Business mileage for gas and travel expenses
- Office supplies and software for business use
- Health insurance premiums if you pay for your own coverage
- Retirement contributions to a Solo 401(k) or SEP IRA
For example, if you make $60,000 but deduct $10,000 in business expenses, you only pay tax on $50,000.
Sole Proprietor vs. LLC: Should You Switch?
As your business grows, you might consider switching to an LLC (Limited Liability Company).
Sole Proprietor vs. LLC – Key Differences
When to Switch to an LLC
- If you want legal protection, since LLCs separate personal and business assets.
- If you make over $50,000 per year, LLCs can lower self-employment taxes.
If you decide to switch business to an LLC, check out our State-LLC Guide for step-by-step formation instructions.
Final Thoughts: How to Pay Yourself and File Taxes the Smart Way
Being a sole proprietor means you are responsible for your own paycheck and taxes. By following these steps, you can pay yourself correctly, set aside money for taxes, and maximize deductions to keep more of what you earn.
Quick Recap
- Pay yourself through an owner’s draw from your business account.
- Track your profits to understand your net income after expenses.
- Set aside 25-30 percent of income for taxes.
- Pay quarterly estimated taxes using IRS Form 1040-ES.
- Lower your tax bill with deductions like home office, business supplies, and health insurance.
