Sole Proprietorship & Retained Earnings

By Tom Streissguth

Small business owners that organize as sole proprietorships enjoy fairly simple accounting and tax-paying chores. Like any other business, a sole proprietorship earns revenue, pays expenses and calculates net income on the difference. Sole proprietors should also keep track of their retained earnings -- the portion of profit that is kept in the business and not paid out to owners, employees or investors.


Sole proprietors have to track income and expenses, like any other business. Unlike corporations or limited liability companies, however, they don't have shareholders or partners to whom a larger business would pay out a portion of profits in the form of commissions, salaries, bonuses or dividends. Instead, a sole proprietor earns taxable net income, which he pays to himself as a salary or keeps invested in the business. The latter money is known as "retained earnings."

Tax Treatment

The IRS considers the business and sole proprietor to be the same. Any net income from the business is taxable income for the sole proprietor, who declares the profit on his annual individual tax return using Schedule C. There is no separate business tax return. The sole proprietor also pays self-employment tax for Social Security and Medicare. Whether or not the earnings are retained, they are taxable, according to the calculation of net income on Schedule C.

Ready to start your LLC? Start an LLC Online Now


A sole proprietor does not keep a separate account for retained earnings, since he doesn't pay dividends out to shareholders or partners. The owner still must keep track of his expenses, revenues and net income, as well as the money he keeps in the business and uses for equipment, transportation, postage, salaries and other expenses. These retained earnings show up on the balance sheet as part of the equity the owner has in the business.

Capital and Draw Funds

A typical sole proprietorship keeps two separate accounts for this equity: Owner's Capital and Owner's Draw. Personal funds the owner used to start up and operate the business, and continues to contribute to it, are kept in the Owner's Capital account along with retained earnings from operations. Owner's Draw, however, is the account from which the owner takes his salary, commissions, fees and any other income. Net income for tax purposes includes any money drawn from the business and any retained earnings for the year.

Ready to start your LLC? Start an LLC Online Now
Base Salary Vs. Equity Split in an S-Corp Partnership



Related articles

Differences Between Sole Proprietorship & Freelance

The freedom to control the process and method when working for another makes freelancing an enticing way to earn income. Those that choose this arrangement over conventional employment have some flexibility in determining how to structure their business, how to be paid, and how to handle profits and losses for income tax purposes.

Sole Proprietorship & Investment Accounts

The sole proprietorship is a very common form of small business, and beyond running their underlying business, sole proprietors are free to make investments and hold assets in investment accounts. These accounts can be used to augment savings for the business, to speculate on specific investment opportunities or to offset financial risks encountered in the sole proprietorship's business operations.

What Can Be Deducted in an S-Corp?

An S corp is a corporation that has elected to be treated as a partnership for tax purposes. This means that the company does not pay income tax; instead, income and deductions flow through to the personal income tax return of each owner. Both an S corp and a C corp have the same deductible expenses; the only difference is who pays the tax.

LLCs, Corporations, Patents, Attorney Help LLCs

Related articles

What Equity Accounts Should I Have for an S-Corp With Two Partners?

Unlike a C corporation, whose earnings are taxed at the corporate level, an S corporation is a small business ...

How to Take Distributions From an LLP

In a limited liability partnership, or LLP, the owners are entitled to take distributions from the company. A ...

How Are Profits Split in an LLC?

One of the significant benefits of organizing a company as a limited liability company, called an LLC, is the ability ...

Can a Partner in an LLC Receive a Salary?

Under the federal tax code, an LLC with more than one member is taxed as a partnership, though the individual owners of ...

Browse by category
Ready to Begin? GET STARTED