How is commission taxed?
How is commission taxed?
Do you currently work in an industry or hold a position where you earn a salary and commission? Are you wondering if or how the commission is taxed? The short answer is yes, like all income it is taxed, but to what extent depends on several things. How your employer pays you is one of them. That will be explained further below, but first, let’s discuss what a commission is.
What is commission?
Commission is additional compensation that is usually earned based on job performance. When you agree to a commission-based role or commission structure (often by signing an agreement), you agree to be paid a certain amount of money that is dependent on you reaching a specific goal like goods sold, leads converted, or hires placed, to name a few examples. By incorporating these factors into their pay plans, employees are rewarded for meeting specific goals.
Industries that earn commission
Commission-based jobs are popular in the business sales field, but you can find them in a variety of industries, including:
- Hospitality
- Advertising
- Real estate
- Finance
- Insurance
- Information technology
Some employees earn commission as well as their base salaries, while others work on straight commission (commission only). However, the process in which they earn commission itself is the same. For example, if an employee sells a software program for $800 and gets a 5% commission on all sales, they’ll earn $40 of commission on that sale.
Types of commission pay
There are a variety of commission structures that businesses use depending on their services or products. The six most common structures include:
- Base Salary Plus Commission – One of the most common commission structures. This guarantees the employee a base salary, plus a percentage of the sales that they make during a given period.
- Straight Commission – Salespeople who work on straight commission only earn money when they complete a sale. No sale equals no income.
- Draw Against Commission – The commission draw model contains elements of the commission-only and the base pay plus commission structures. It’s based on an advance payment, or draw, that helps new hires acclimate to their sales roles without losing income.
- Tiered Commission – The employee’s commission rate increases after closing a certain number of deals or reaching specific revenue benchmarks.
- Residual Commission – The residual plan benefits salespeople with ongoing accounts or clients. As accounts continue to generate revenue, commission payments continue.
- Gross Margin Commission – With the gross margin commission model, rather than earn a percentage of the revenue, you earn a percentage of the profit.
- For example, if you sell a product for $2,000 and it has $800 worth of expenses, you would earn a percentage of the remaining $1,200.
What does commission mean to the IRS?
A commission is considered a “supplemental wage” by the Internal Revenue Service (IRS). The IRS defines supplemental wages as wage payments to an employee outside of their regular wages. Putting commission in the same category as bonuses, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases, and payments for nondeductible moving expenses.
How is commission taxed?
The taxes on commission is calculated based on how your employer pays you. If your commission or bonus is included in or a part of your regular pay, then it’s taxed according to normal federal and state withholding. If you receive it outside of your regular paycheck, then it becomes supplemental and your commission is taxed at a rate of 25%.
More information about which supplemental wages are taxed can be found in IRS Publication 15 (Circular E). If you need help with your taxes, contact us.
