Wednesday, November 1, 2006

How does a self-employed pay himself?

Hi June,

Just started a new business – irrigation installation. When you own your own business is it more beneficial to pay yourself a salary or are you able to write yourself checks as needed for living expenses from the profits?

Shawn in Oklahoma

Dear Shawn,

You, like many self-employed, use the wrong term when referring to money you want to take out of your business. The only people who can earn a salary are employees. You’re a new business and you didn't say that you are incorporated so then you must be a sole proprietorship. And you can’t be an employee of your own sole proprietorship.

You are your business. Your business is you. You bring in money from clients. You pay out expenses. What’s left is profit. Profit is what you’ll pay tax on and profit is your “income.” How you take money out of your business, or when you take it, or how much you take has no effect on your profit. If the money is there you can take it out whenever you want.

Here’s an example: In one month a client pays you $5,000. You purchase $5,000 worth of supplies on a credit card. Your profit for the month is zero. That’s $5,000 income minus $5,000 expense. But you still have $5,000 in your pocket because you took none of it out of your pocket for supplies – you put it all on credit card and haven’t paid the credit card company yet. You can take that $5,000 and go on vacation to Tahiti. Not a good idea but you could do it!

And, as always, read the book that can simplify your tax and financial life, AND save you money! SELF-EMPLOYED TAX SOLUTIONS .



Martha said...

My concern, now that I am a sole- prop with only on-line sales (, is how can I deduct any money for social security in order to pay into my future SS fund? It's already looking rather slim b/c of the lean years before I became an S Corp, and then after the corp. was ended. If I missed this in another post, pls just direct me to it. Thank you for your time & what you do for those of us who are not so conversant with tax issues.

June Walker said...

Dear Martha,

If you are asking how you pay self-employment tax [SE Tax], which is a combo of social security tax and Medicare tax, when you have a profit the answer is that the amount you pay is calculated on your tax return and that amount becomes part of your total tax liability for the year?

If you are asking whether you can pay into social security even though you had a loss: Yes, you can. The calculations must be done by your tax pro and are part of your tax return.

And, you are welcome. So pleased my writing is helpful.



Dave Dirt said...


Thank you so much for your wonderful advice. I have been freelancing on the side for several years, and just recently left my job and decided to go full-time SE. My business is a sole-prop. & I want to make sure I begin to pay taxes correctly. I understand the combined Medicare & SS taxes I have pay, and income tax. Could you go into detail a bit more about what the IRS call a draw account? I'm not too clear on how exactly I take money from the business for my own personal use and still pay the right amount of taxes. Thank you again.

June Walker said...

Dear Dave,

If you reread this post you'll see that your profit is what you have left of your business income after you have paid expenses.

A client pays you $10,000 and you have business expenses of $6000 then you have a $4000 profit. It is on the $4000 that you pay federal and state income taxes as well as SE tax [social security & Medicare].

There is no "draw" for sole-proprietors. How much of the business profit you use to pay for rent, groceries, a vacation has no impact on your profit. It is on your profit that you pay tax.

In my example let's say that you let that $4000 profit sit for a year or so -- because you are living off grandma's trust fund and don't need the money -- you will still pay tax on the $4000.

If you use the $4000 to pay rent and you have no money left, you must still pay tax on the $4000 profit.

Please let me know if this is not clear.

-- June

Dave Dirt said...

I see now. No matter what I do with my money, I just have to pay taxes on the profit. (Income minus Expenses) Thank you. I have found this website to track the amount of tax I need to pay. Do you have any experience with this site?

June Walker said...

You got it, Dave. You figured it out. Great.

Altho I've heard of outright and have been contacted by outright I have no experience with it. Please let me know if it works for you.

-- June