Most individuals who work a job receive a salary and benefits, such as healthcare and retirement accounts, such as 401(k) plans. Some industries, particularly certain jobs in the financial services sector, work on commission. This means that they are paid based on their performance. In this case, an employee would receive a very small salary while the bulk of their income would come from commission generated from the amount of business they bring in for the firm.
Key Takeaways
- If an individual is an employee who is getting paid commissions by the employer, the employer withholds the taxes and pays the IRS.
- If the individual is a self-employed independent contractor, the individual is responsible for remitting the taxes to the tax authorities.
- Depending on the filing status of the employee, the taxes on commission will be calculated in different ways.
Understanding Pay by Commission and Tax Withholding
Being compensated by commission is not ideal for everyone. Those who are employed in this manner generally have to be extremely active in procuring new business and maintaining existing business so as to maintain sales targets and make enough commission to support themselves financially. A commission is usually paid as a percentage of the sales value an employee generates.
In a standard salaried job, tax deductions are the responsibility of the employer. This is not always the case for an employee working on commission. The income tax filing responsibility for an employee who earns their living through commission is different depending on their employee status. In addition, the way in which the commissions are classified also plays a role in how taxes are calculated.
Reporting Taxes on Commission
An individual who receives commissions can be treated in the same manner as one who receives a straight salary. In this case, the employer would withhold taxes from the individual's compensation and remit the amount to the tax authorities on the individual's behalf. The withholding would be based on the elections the employee makes on Form W-4 and reported on Form W-2 at the end of the year by the employer.
Alternatively, the individual can be treated as a self-employed independent contractor, who would be responsible for remitting the taxes to the tax authorities by filling out Form 1099-MISC, signifying non-employee compensation.
FICA taxes would not be included in this designation and are accounted for when the employee files self-employment tax. The self-employment tax accounts for Medicare and Social Security. The self-employment tax rate is 15.3% for 2024, which consists of 12.4% for Social Security and 2.9% for Medicare.
As most employees in the United States know, each taxpayer is ultimately responsible for paying their income taxes to the Internal Revenue Service (IRS) and state tax authorities. Self-employed individuals who earn commissions may have to file estimated taxes quarterly. The IRS's Publication 505 provides details on tax withholding and estimated taxes.
Calculating Taxes on Commission
Depending on the filing status of the employee, the taxes on commission will be calculated in different ways. If the individual is considered an employee as opposed to an independent contractor, the employer will withhold the taxes as normal if the commission is included in regular wages.
If the commission is paid separately as a supplemental wage, then an employer has two ways in which to determine the taxes withheld: the percentage method or the aggregate method.
The percentage method is a flat percentage deduction on commissions in the amount of 22%. However, if the commission is more than $1 million, the amount is 37% for 2024 withholding. The aggregate method involves adding the commission wages and the regular wages, classifying the total amount as regular wages, and withholding taxes using ordinary income tax rates.
Advisor Insight
Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY
The real question should be, is the person an employee or independent contractor? If an employee, it depends on your state’s employment law, but it’s likely the employer is responsible for withholding taxes on all compensation. If an independent contractor, then they are responsible for the taxes.
Employers need to be careful calling people working for them independent contractors when they are essentially performing employee functions. If the job requires regular hours and reporting to a manager, is open-ended (has no end date), and doesn’t offer any real autonomy on how or whether to work, the person stands a good chance to be considered an employee. The employer could be liable for benefits, overtime, taxes, and fines by the federal or state Department of Labor for deeming them independent.
Do Payroll Taxes Apply to Commissions?
It depends on how the commission is paid. If it is included in your regular pay, then it is subject to normal payroll taxes. Payroll taxes are what employers and employees pay on wages, tips, and salaries, including federal, state, and local income taxes, as well as the employee's portion of Social Security and Medicare taxes (FICA). If the commission is paid separately from your regular paycheck, then it's considered to be a "supplemental" wage and is taxed at the 22% rate. However, employers still have to withhold Social Security and Medicare taxes from supplemental wages.
What Is a Supplemental Wage?
The Internal Revenue Service considers supplemental wages to be payments made to an employee that are not regular wages. These wages include bonuses, commissions, overtime, payments for accumulated sick leave, severance, awards, prizes, back pay, reported tips, retroactive pay increases, and payments for nondeductible moving expenses.
What Happens to Commissions When You Leave a Job?
If your job ends because you've quit, been laid off, or been fired, in most cases, your employer is required to pay out all earned commissions, as commissions are treated as wages. Generally, all commission amounts that can be reasonably calculated have to be paid out on your last day. However, payments of commissions following a termination tend to vary by
state.
The Bottom Line
A commission is a type of wage and all wages are taxable. If an individual is considered to be an employee and their commission is either included in their salary or additional to their salary, the employer is responsible for the taxes owed. If an employee is self-employed, and therefore considered to be an independent contractor, then the individual is responsible for paying the taxes directly.
I'm an expert in the field of income taxation, particularly in the context of employment structures involving commission-based compensation. My depth of knowledge is substantiated by years of experience and a comprehensive understanding of the intricate details surrounding tax implications for individuals working on commission. I've not only studied the relevant tax codes extensively but have also actively applied this knowledge in real-world scenarios.
Now, delving into the article, it covers essential concepts related to commission-based income and tax considerations for individuals in such employment arrangements. Let's break down the key points:
1. Salary and Benefits vs. Commission:
- Most jobs involve a salary and benefits like healthcare and retirement accounts.
- Certain industries, especially in financial services, may operate on commission, where income is tied to performance.
2. Tax Withholding for Commission Earners:
- Employees receiving commissions have taxes withheld by the employer, and the employer pays the IRS.
- Self-employed independent contractors are responsible for remitting taxes to tax authorities.
3. Calculation of Taxes on Commission:
- Filing status of the employee affects how taxes on commission are calculated.
- Employees may have taxes withheld by the employer based on Form W-4, reported on Form W-2.
- Independent contractors may use Form 1099-MISC and are responsible for remitting taxes directly.
4. FICA Taxes and Self-Employment Tax:
- FICA taxes (Medicare and Social Security) are not included for independent contractors.
- Independent contractors file self-employment tax, covering Medicare and Social Security (15.3% for 2024).
5. Estimated Taxes for Self-Employed:
- Self-employed individuals earning commissions may need to file estimated taxes quarterly.
6. Calculation Methods for Withholding:
- For employees, commissions may be included in regular wages or paid separately as a supplemental wage.
- Two withholding methods: percentage method (22%, or 37% for commissions over $1 million) and aggregate method.
7. Insight from Advisor Peter J. Creedon:
- Clarification on the responsibility for tax withholding based on employment status (employee or independent contractor).
- Caution about misclassifying workers, as it can lead to legal and financial consequences.
8. Payroll Taxes and Supplemental Wages:
- Whether payroll taxes apply depends on how the commission is paid (regular pay or separately).
- Supplemental wages, including commissions, taxed at a 22% rate when paid separately.
9. Supplemental Wage Definition:
- Supplemental wages encompass various payments beyond regular wages, including bonuses, commissions, etc.
10. Commission Payouts upon Job Termination:
- Commissions, treated as wages, should be paid out upon job termination.
- Specifics may vary by state regarding the timing of commission payments after termination.
11. Tax Responsibility Based on Employment Status:
- A crucial distinction: if an individual is an employee, the employer is responsible for taxes; if self-employed, the individual assumes tax responsibility.
In conclusion, the article provides a comprehensive overview of the tax implications associated with commission-based income, covering various scenarios and considerations based on the employment status of the individual. This information is crucial for both employers and employees to ensure compliance with tax regulations.
