How to pay yourself as a sole trader or proprietor (simple answer and long version)

The simple answer is this. In your accounting system, all you have to do is create a transaction that does this:

DEBITS the Drawings Account (the Drawings Account is an Equity Account) for the amount you want to ‘pay’ yourself say… $10,000 and,
CREDITS the Cash Account for $10,000

As a sole proprietor, when you take money out for living expenses or whatever you need it for, it’s not considered a ‘wage’. A wage/salary payment is money that is provided to an employee and can be deducted by the business as an expense. If you are making drawings (i.e. taking money out of the business to ‘pay’ yourself, those drawings are not deductible as an expense by the business.

Here’s the long reason why:

In Australia, if you operate as a sole trader, you’d include your business income in your own personal income tax return.

So take for example, this business:
Business has:
$20,000 income, less
$10,000 in deduction
= $10,000 in profit (assume you have $10,000 in cash too that represents this profit).

So, the business has $10,000 in profit (taxable income). Tax would be applied to that based on the year’s tax rate. In 2014-15, the tax rate was 0% if taxable income was less than 18,200 so in reality you wouldn’t have to pay any tax on this $10,000 if that’s all your income for the year. But let’s assume that tax rate is 5 cents for every dollar. In this case, tax applicable would be $500 (10,000 x 0.05).

The drawing that you’ve made makes no difference to the calculation of tax because the drawing of $10,000 doesn’t affect profit. See:

You withdraw = $10,000 in cash.

Business naturally now has $0 in cash.

But… tax is calculated not on how much cash the business has but on profit. So that tax is still $500 ($10,000 in profit x 0.05) and included in your individual tax return. The drawing is just a movement of cash from the business to your personal pocket. You wouldn’t include the drawing you’ve made as income when you do your tax return because it’s really business income, which you’ve been taxed on and… because you’re a sole trader, belongs to you. smiley

Next: Difference between Type 1 and Type 2 Fringe Benefits

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