The Ultimate Guide on Sole Proprietor Payroll in 2024

A sole proprietor is someone who takes on a solitary business venture or freelance project. Sole proprietorship is characterized by a simple, fuss-free structure, making it quite a popular business type in the US.

But what does a sole proprietorship truly entail? How do sole business owners earn money and pay their employees? What are the pros and cons of being a sole trader, and how does that compare to other business structures?

If you want to find out, you’ve come to the right place! This article will provide you with all the answers you need and more.

So, let’s jump straight into it!

Key Takeaways

• A sole proprietorship is an unincorporated business structure that’s easy to build but takes years and twice the effort to expand and maintain.
• Being a sole proprietor offers you more autonomy and flexibility in terms of decision-making, set-up, profits and investments, and business longevity.
• A sole proprietor’s earning is the profit that their business makes. It is ideal to settle all financial liabilities, taxes, and expenses responsibly.
• Sole proprietors can hire and pay employees and are subject to settling taxes based on their business structure.

What is a Sole Proprietorship?

A sole proprietorship is a stand-alone business owned by a single owner. The owner has full authority over every single aspect of their small business, something that larger corporations would otherwise delegate to a team of experts or split between shareholders.

In 2022, a survey conducted by Guidant Financial on small business owners found that only 4.7% of the respondents had reached the 20-year milestone. Conversely, around 51.6% of respondents are either in the first few years of their business or have made it to their venture’s 5-year mark.

The business structure of a sole proprietorship is not considered a legal entity. Rather, it is deemed an extension of the business owner themself.

You can be a sole trader while you are employed in a different company, do it full-time, or use it as a side hustle for extra income. Sole proprietors can also have employees.

What Do You Need to Create a Sole Proprietorship?

To create a sole proprietorship, you must secure the following factors:

• Business name. Most sole traders take it the easy way and incorporate their name into their business.

• Business plan. It details what your business is all about. Your business plan enumerates the product or service you are selling, your target market, and your strategy for growing and expanding your business.

• Registration. You need to register a business DBA name if you are to use a trading name. It indicates you are operating a business as a sole proprietor using a business name. In contrast, using your legal name for your business enables you to operate without a DBA name, but you will need to use your Social Security number to pay your taxes.

• EIN (Employer Identification Number). This number is typically needed if you register for a DBA name, pay excise taxes, or hire employees. Your EIN is used in identifying your business to fulfill your tax obligations.

• Domain. It would be a waste not to purchase a domain name and build a website in today’s market scene. Small businesses benefit largely from establishing an online presence because it helps them reach a broader audience.

• License & permit. It is best to learn your business type’s specific license and permit requirements. Securing a business permit will also depend on your state, so make sure to consult your local legal authorities.

Benefits & Drawbacks of Sole Proprietorship

The simplistic role of a sole trader has both advantages and disadvantages. Read more about them in the section below!

Sole Proprietorship Benefits

#1. Less paperwork. Technically, a sole proprietorship has no legal or formal separation, especially if you are using your full legal name to represent your business. Sole traders can settle their tax obligations through their personal tax returns.

#2. Reduced costs and fewer fees. It costs less to create a sole proprietorship than it does to create a company. Consequently, taxes applied on the business income may even be significantly lower—with some owners able to qualify for up to20% tax deduction.

#3. Full control of your business. As the sole proprietor, you do not need to heed another party’s proposal or directive. The business is built upon your ideas, your desired setup, and your decision-making.

Sole Proprietorship Drawbacks

#1. Legal and financial vulnerability. Unlike limited liability companies (LLCs), sole traders are more susceptible to covering legal and financial liabilities. The worst part is you will have to use your personal funds to cover these losses, whether unprecedented or not.

#2. Profit vs. debt. As much as you get full profit, you must also settle any incurred debts while operating your business. It becomes an even more serious problem if you don’t have a solid bookkeeping process.

#3. Lower chances of lender approval. The majority of lenders are often hesitant to lend money to a sole proprietor. Only a few lenders look past your assets and financial credibility and focus on your business’s earning potential.

How Sole Proprietors Pay Themselves

If you’ve noticed, the greatest difficulties of sole proprietors involve money. This begs the question, how do you get compensated as one?

When do Sole Proprietors Pay Themselves?

As a sole proprietor, you do not earn a salary but instead earn profits.

Being a sole trader means you can withdraw your earnings from your account anytime. All you have to do is write a check for yourself and indicate the amount you want.

A sole trader withdrawing money from their own business is identified as a disbursement or an owner’s equity.

Ideally, you must create a separate business account from your personal account. Doing so keeps your financial records and expenses well-organized and easy to update.

It saves you the trouble of mixing sole proprietor payroll wages with personal expenditures. You can also schedule a bank-to-bank transfer to withdraw money from your business account to your personal account.

How Much do Sole Proprietors Pay Themselves?

The answer to this question is simple, and it depends on your net profits. Your net profit is the remaining balance from your revenue following the deduction of your expenses.

Generally, when you withdraw money from your business for personal reasons, it is called an “owner’s draw.”

It’s advisable to give your business time to earn more profit to build cash reserves and cover regular business expenses or emergency fees. Only get the amount you need to cover your daily finances and avoid unnecessary expenditures.

Computing your business’s quarterly earnings in advance is another alternative worth trying. Assess how much you expect to earn long-term, and if the results predict stable profits in the coming months, you can take a significant percentage of your profit quarterly.

How do Sole Proprietors Pay Taxes?

You and your business are considered one entity. Hence, you qualify for pass-through taxation. Simply put, your business is not taxed, and all gains and losses in your business are reflected on your personal income tax return.

In that regard, your taxable income increases as your business’s net income doubles.

To fulfill your sole proprietor payroll taxes, you’ll need to complete a Schedule C form. Schedule C is used to report the profits and losses of your business. You must also accomplish Form 1040 to file your annual income tax return.

Self-employment taxes are contributions that sole proprietors are obligated to cover. These include the Medicare and Social Security systems. As a sole proprietor, you are required to pay these taxes in full.

Additional taxes such as property taxes, employment taxes, as well as sales and excises taxes will depend on whether you:

• Own a business property or any kind of real estate for your sole proprietorship.
• Hire employees to operate your business.
• Sell services and products where sales and excise taxes are applicable, such as retail services and the sale of tobacco and alcohol.

How Sole Proprietors Pay Employees

Sole proprietors can hire as many employees. Once you do hire employees, you bear the responsibilities of a regular employer.

Proprietors must apply for an Employer Identification Number (EIN) at the IRS website. Next, employees are entitled to fill out forms W-4 (Employee’s Withholding Certificate), I-9 (Employment Eligibility Verification), and other important employment documents.

After both parties fulfill the essential forms, sole proprietors can start calculating their employees’ salaries using the following steps.

#1. Compute Your Employees’ Individual Gross Pay

If your employees are paid a fixed salary, get the total of their annual salary, then divide it by the total of pay periods within that year. Exclude holidays from the pay periods. In case an employee works on a holiday, the computation for the extra hours they rendered shall be done on the payroll cutoff where the holidays fall in.

In case your employees are paid per hour, get the total number of hours rendered and multiply it by the corresponding hourly rate. Overtime hours are computed separately. You compute it by combining all overtime hours rendered, multiplying the total by the overtime rates, and adding it to the total number of regular work hours rendered.

#2. Withhold the Following Deductions

The deductions you need to withhold include:

• Pretax deductions. These cover your employee’s contributions for benefits such as healthcare and retirement savings.

• Statutory deductions. Anylocal and state taxes (you can verify this with your local authorities), federal income tax, and FICA tax (Federal Insurance Contributions Act) are included in statutory deductions. FICA contributions fund Medicare and Social Security programs.

• Post-tax deductions (after-tax deductions). These are additional deductions on employees’ salaries or paychecks after taxes. Note that both pre and post-tax deductions are voluntary contributions, meaning you are not legally obligated to deduct them. Examples of post-tax deductions are charitable contributions, life insurance, and garnishments.

Payroll Differences: Sole Proprietors vs. Other Company Forms

How do sole proprietor payrolls differ from those of other business structures? Find out in the following section!

#1. Sole Proprietors vs. Self-Employed

Sole proprietors are unincorporated businesses whose structure qualifies for income tax. Self-employed means that an individual works for themselves. Both are considered independent contractors and are subject to self-employment taxes.

#2. Sole Proprietors vs. Corporations

Sole proprietors fall under pass-through taxation. Corporations are required to pay double taxation. First, they must pay taxes based on their company’s profits and then settle shareholders' taxes.

#3. Sole Proprietors vs. Freelancers

Freelancers offer their services to one or more business entities and get compensation in exchange. Payroll taxes are not deducted from a freelancer’s paycheck, but they may receive a 1099-NEC form.

Check out our guides on how to create invoices if you are a self-employed individual or a freelancer.

Sole Proprietor Payroll FAQ

#1. How do I pay myself as a sole proprietor?

The profits made by your business are your pay. The amount you withdraw from your profits to cover your personal expenses is solely up to you. However, you must consider all other expenses and financial responsibilities associated with maintaining your business.

#2. Can a sole proprietor have payroll?

In essence, no. You are not an employee of your own business. Your profit is your pay, and you are obligated to settle all taxes that come with being a sole proprietor.

#3. How many employees can a sole proprietor have?

There is no limit to how many employees a sole proprietor can have. It all depends on your budget and your business needs. Some proprietors even choose to employ their families.

Final Thoughts

The choice to become a sole proprietor is quite a bold move, considering the many financial challenges and risks it entails. However, equipping yourself with the right knowledge is important, such as knowing what defines your earnings, when and how to settle your taxes, and understanding the circumstances when hiring employees as a sole proprietor.

All this information helps create the foundation you need to overcome these challenges and prepare your venture for success.