Did you know that nearly 1 in 3 Americans is self-employed? While that includes people working as independent contractors on a part-time basis, about 14% of Americans are lucky enough to call themselves their own bosses full-time.
As remote work becomes mainstream and the gig economy grows, so too will the number of “solopreneurs” in the United States.
Have you recently joined the millions of freelance workers, independent contractors, and sole proprietors in this country? Are you thinking about it? If so, you probably have many questions about the logistics.
While starting a business or having clients is exciting, it also comes with new administrative tasks, like doing payroll. Today, we’re answering your most pressing questions about how to pay yourself as a self-employed individual.
- Who qualifies as a self-employed worker
- What payroll is
- How to pay payroll if you’re self-employed
What Does Being Self-Employed Mean?
According to the IRS, being self-employed means one of three things:
- You conduct business or have a trade you perform as an independent contractor, or as the sole proprietor of your own business.
- You are a member of a business partnership.
- You have your own business through some other means, including running a business part-time, like a side hustle.
Here we’ll focus on the first definition of self-employment: acting as an independent contractor for another company or operating your own business as a sole proprietor.
So what’s the difference between a sole proprietor and an independent contractor?
A sole proprietor is someone who runs their own unincorporated business. If a company isn't incorporated, it isn't considered as a separate legal entity from its owner. In other words, the business owner and the business are the same under the law. Sole proprietors file a Schedule C alongside their IRS Form 1040 at the end of the year.
An independent contractor doesn’t have their own business per se, but instead works for one or more clients without being considered an employee. According to the IRS, people are independent contractors if the company that pays them controls the deliverables they provide or the outcome of their work, but not when, how, and what will be done. Gig workers like Uber and Lyft drivers are typical examples of independent contractors — or at least they were until a recent California judge’s decision.
Both sole proprietors and independent contractors receive 1099-NEC forms (new for 2020, used to be 1099-MISC forms) from their clients at the end of the year. Because their clients don't withhold a sole proprietor's taxes, they're responsible for paying their own income and payroll taxes on their personal tax return.
What Is Payroll?
Payroll can mean one of three things:
- A business’s list of employees and how much they get paid.
- Payments made to employees by an employer in the form of salaries or wages.
- The process a business takes to pay employees their salaries and wages and file employment taxes. This process is known as “running payroll,” “processing payroll,” or “doing payroll.”
The bottom line is that payroll has to do with paying employees the salaries and wages that they are owed.
How Do You Pay Yourself If You Are Self-Employed?
Technically, self-employed individuals cannot run payroll to pay themselves. Why not? Because running payroll involves giving someone a wage, and sole proprietors aren’t eligible to receive wages or have their taxes withheld.
Self-employed individuals have to pay themselves by taking a taxable, small business owner’s “draw” from their business’s funds.
You can take draws at regular intervals so that it feels like you are getting a salary. However, taxes aren’t withheld from these draws, so you’ll have to pay quarterly estimated taxes to make up for that.
Here’s how to pay yourself if you are a self-employed individual:
1. Open a Bank Account for your Business
A separate bank account for your business will keep your company’s funds separate from your own. Requirements for opening a bank account for a sole proprietorship vary from bank to bank.
However, most will ask for:
- A business tax ID, like an EIN (Employer Identification Number) from the IRS,
- A legal business name, trade name, or DBA (“Doing Business As”)
- A business address
- Your personal identification information, like a state ID or license
- Proof of business name registration, like proof that you’ve filed a DBA
Check out Bank of America’s website for an example of the documents you’ll need to show to open a bank account for your sole proprietorship.
When your business bank account is open, start depositing all of the revenue your business generates into that bank account instead of your personal bank account.
2. Decide How Much and How Often to Pay Yourself
After you’ve accumulated enough funds in your business’s bank account to cover several weeks’ or months’ worth of expenses, you should start paying yourself. Decide how much you want to pay yourself and how often.
Decide How Often and When to Pay Yourself When You Are Self-Employed
Some self-employed individuals pay themselves whenever a client fulfills an invoice. Others mimic corporate pay periods and pay themselves bi-weekly or monthly.
Decide how often and when to pay yourself based on your needs. When do your major life expenses, like rent or a mortgage, tuition, or childcare, have to be paid?
For example, if you pay rent on the first day of each month, you may want to pay yourself on the 25th of each month so that you can have the funds in your personal bank account several days before the rent is due.
Decide How Much to Pay Yourself If You Are Self-Employed
Base how much you pay yourself on two things:
- How much money you have coming into the business
- How much money you have going out of the business (i.e., your business expenses)
Let’s say that your business brings in $10,000 each month, and you have roughly $2,000 in business expenses each month. Because your business expenses fluctuate, you also want to give yourself a buffer — in this case, about $2,000.
After business expenses and that buffer, you have $6,000 left each month. If you want to pay yourself bi-weekly, you will pay yourself $3,000 every two weeks.
3. Pay Yourself
Pay yourself on your chosen paydays by transferring money from your business’s bank account into your personal bank account. You can automate this process by setting up a recurring transfer between your accounts.
4. Pay Self-Employment Taxes
Because you don’t withhold taxes from your self-employed “paychecks,” you’re responsible for a tax bill that includes making estimated quarterly tax payments to the IRS and your state and local tax agencies.
You’ll need to pay the following taxes:
Federal Self-Employment Taxes
Self-employed individuals owe the federal government payments towards their income taxes and self-employment taxes every quarter.
Income taxes are based on IRS tax brackets and your best estimate of your net earnings for the year. For example, if you forecast that your business will make $100,000 in profit this year and file your taxes as a single person, you'll fall into the 24% tax rate bracket.
Divide $100,000 by four, and you’ll find your estimated business income for the quarter, which is $25,000. Multiply that by 24%, and you’ll find that you should pay $6,000 each quarter to the IRS in estimated income taxes.
If your estimate is incorrect, you’ll have to pay what you owe or get back what you overpaid when you file your tax return.
Self-employment taxes are a flat-rate for sole proprietors and include a 12.4% payment toward FICA (Federal Insurance Contributions Act) for Social Security and 2.9% payment for Medicare taxes.
These taxes can be paid online through the IRS’s EFTPS (Electronic Federal Tax Payment System) following the IRS’s estimated tax payment schedule.
State Self-Employment Taxes
Most states require sole proprietors to file estimated quarterly income taxes and, in some cases, state payroll taxes.
Check your state’s tax agency for details about tax rates and deadlines.
Local Self-Employment Taxes
Self-employed individuals who live in municipalities that impose local taxes will also have to make quarterly payments. For example, sole proprietors and independent contractors who work in Philadelphia have to pay a Business Income & Receipts Tax (BIRT) and Net Profits Tax, while employers pay a quarterly city earnings tax.
Final Thoughts: How to Pay Payroll When You’re Self-Employed
Self-employment is on the rise in the United States, and it’s only going to become more popular. Paying yourself as a sole proprietor is different from receiving a paycheck from a W-2 employer. Since your taxes aren’t withheld, and you’re not eligible for a salary, you have to pay yourself by taking an owner’s draw of your business’s income.
Sole proprietors can mimic payroll by putting their business’s revenue into a separate bank account, taking an owner’s draw at regular intervals, and paying estimated quarterly tax payments throughout the year.
As your business grows and you form a legal business entity, like an LLC (Limited Liability Company) or an S-Corporation, you’ll be able to hire employees and pay them via payroll. Additionally, you’ll want to think about payroll services that integrate with time tracking functionality so you can track efficiencies.
When that day comes, Hourly can help you manage payroll processing and time tracking for your employees. Learn more about how Hourly can take payroll off of your plate.
1. Introducing Yourself
Your introductory email needs to pack a lot of information into a small package. Try something like this:
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My name is John Doe and I work for ABC Agency, where we provide business insurance policies to many of Dallas' rockstar small businesses.
Congratulations on your new business, Jane's Bakery. Are you wondering if you have all the insurance you need? Or if your policies will really cover you in a pinch?
At ABC Agency, we pride ourselves on providing robust, comprehensive coverage options to companies like yours with flexible, pay-as-you-go plans.
Are you available this week to talk more about how we can help? I can help you find the most affordable rates and the best policies out there.
I look forward to speaking with you soon.
2. Presenting a Quote
Once you've met with your potential client, a quick reply with their quote will get the ball rolling.
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Thanks so much for meeting with me this morning. I loved touring Jane's Bakery–I can still smell those delicious chocolate chip cookies baking! You have a great location, and I'm sure you're going to do great on Front St.
After reviewing my notes, I've pulled together an insurance quote for you (attached). I recommend a business owner's policy. A BOP includes several insurance products in one: liability, property insurance, and business interruption insurance. It offers robust coverage at a competitive price.
I'll call you in a few days to see what you think about this insurance plan. In the meantime, if you have any questions, don't hesitate to email me or call me at [phone number].
Again, thank you for your time today. I look forward to working with you in the future.
3. Thanks for Purchasing a Policy
Gratitude is important! It's never a bad idea to thank your clients for their business.
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Thank you for choosing a business owner's policy with ABC Agency. We know it's so important to get the right coverage for your business, and we are honoured you've placed your trust in us.
We're excited to work closely with you, and our no. 1 goal is to make sure you're business is always protected.
Do you have any questions? We are here to help. Reach out whenever something comes to mind.
Thank you again for choosing ABC Agency to insure Jane's Bakery.
4. Welcome Email
A welcome email helps clients feel like you're there to help–and can softly pitch other insurance products you offer.
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Welcome to the ABC family! We are thrilled to have you as a new customer and can't wait to meet all of your insurance needs.
As an independent insurance agency, we work with multiple insurance providers to find the best coverage options for all our customers. If you need any other type of insurance–like [include additional offerings unique to your agency, like life insurance, health insurance, home insurance or anything else]–we can help you too.
Do you want to discuss any of these policies?
5. Introducing a New Product
A happy client may want to expand their business with you.
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I hope all is well with you and Jane's Bakery. I stopped in yesterday for a blueberry muffin and coffee, and they were delicious. I loved the hint of cinnamon in the muffin! Was that your idea?
I wanted you to be the first to know we are now offering commercial vehicle insurance to our policyholders. Auto insurance for your catering vans is super important since your personal car insurance won't cover them.
We're offering this insurance coverage solely to our current business clients at the moment and have some very competitive rates.
Would you like me to work up a quote for you?
As always, thanks so much for being a part of the ABC family.
6. Asking For Referrals
Once your relationship is established and comfortable, let your clients help you grow.
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You've been a valuable member of the ABC family for two years now, and we so appreciate your business–not to mention the muffins you supply for our monthly meetings!
Because you are a valued policyholder, I wanted to ask a quick favour. I know you are active in the local Chamber of Commerce, and I'm hoping you might know some colleagues who would benefit from working with our insurance company.
Referrals are one of the most effective ways to connect with our community since people really trust their friends, family and colleagues. Is there anyone you'd recommend I speak with?
Remember that in addition to business insurance products, we offer everything from life insurance policies to pet insurance.
As a thank you for your help, we will send you an Amazon gift card of $100 when your referrals buy insurance from us.
Thanks so much for your help!
7. Policy Renewal
If your client needs to renew their policy with you, send an email like this:
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I hope you're doing well! What a year it's been—from being listed as one of the top 5 bakeries in Dallas to being an official vendor for the city—you have so much to be proud of.
Just a heads up that your business owner's policy is up for renewal soon and will expire on June 15, 2023.
If you're still happy with the coverage, we can easily renew it for you.
Do you have some time to chat this week?
Looking forward to serving you again!