A big difference between a limited liability company, sole proprietorship and a limited partnership is how you as an owner charge a salary. We have previously looked at how salaries or dividends are paid in limited liability companies. Now we are changing the focus and this article is aimed at those who want to know how to handle the salary through their own withdrawals in sole proprietorship.
Prerequisites salary sole proprietorship
As an owner of a sole proprietorship, you can never be both owner and employee. This means that there is really no classic salary to tell individual traders. Your personal finances and the company’s finances are more or less one. When you need money privately, you do not pay the salary as to a regular employee, you make your own withdrawal.
Private withdrawal sole proprietorship
A private outlet is what the name gossips about. You pick out actual assets like money and goods out of the company or use the company’s funds to pay your private expenses. The source of the own withdrawal is the company’s own capital. It, in turn, comes from deposits and past years of earnings. Thus, the profits and investments of the sole proprietorship carry out the pool of capital that will be your salary.
Tax own withdrawal
You do not pay any taxes on your own withdrawal. The Income Tax your sole proprietorship is based on the results of the business and not how much money you pick out. As is known, earnings in your sole proprietorship are income minus costs. You should pay profit tax and co-charges on the performance of the business and it is completely independent of how much own withdrawals you make.
Here a small problem arises that you need to keep track of. As I said, you pay tax on profit for the year and the exact amount of tax for the year you know only at the annual financial statements. The risk is that you make too large withdrawals and do not have enough cash to pay any residual tax.
How, then, can you plan your own outlets to avoid problems? You will most likely need money during the year and not just as a lump sum when you know the results of the year. A common rule of thumb is that 50% of the earnings disappear in taxes, which means you can withdraw about half of the profits each month. If you want to be on the safe side, it is best to make a proper calculation for your profit and tax.
In addition, it is important to remember that profits do not always reflect the cash flow in the sole proprietorship. For example, an investment in a larger machine is recognized as a depreciation that is a cost over several years even though you pay for the investment directly. This means that the purchase affects your liquidity more than your earnings. The risk is therefore that you may lack cash to pay any taxes, even though the result is positive and you only made your own withdrawals within the framework of profit for the year and tax.
Account for own withdrawal
The own withdrawal is not a deduction (cost) that affects the taxable profit of your sole proprietorship. But this does not mean that you do not have to report it in the current accounts and when you make your own withdrawal, you should report it in the accounts.
You account for your own withdrawal by crediting (reducing) an asset account and debiting (reducing) an account for equity. Now we see that the own withdrawal does not affect the result because it is only accounts in the balance sheet that are concerned.