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Taxes on Commissions: Overview
People who “work on commission” may receive a nominal salary but the bulk of their income comes from payments that are based on performance. The financial services sector in particular is notable for paying its employees based on the amount of money they bring in for the firm.
So, who is responsible for paying the income taxes? If the individual is a company employee, the employer will withhold the estimated taxes due. If the person is an independent contractor, the employer won’t withhold taxes, and the contractor is responsible for paying the amount due.
Key Takeaways
- Employers withhold estimated taxes on commission payments to their employees.
- Independent contractors are self-employed and therefore are responsible for reporting their income and paying the taxes due.
- Like most self-employed people, contractors are required to file and pay taxes quarterly.
- Contractors will owe income taxes, Social Security taxes, and Medicare taxes on the amount paid.
Understanding Commissions and Tax Withholding
A commission is a payment of a percentage of the money that an individual has brought into a company through sales or other revenue-generating activity.
Compensation by commission is not ideal for everyone. Those who are paid in this manner have to be extremely proactive in procuring new clients and nurturing existing clients. They must meet sales targets to make enough money to support themselves.
People who work on commmission may be employees or independent contractors.
For employees, commission payments, like salary, are paid after tax withholding. Contractors get paid the gross amount due and have to pay the taxes due on their own.
In either case, the way in which the commissions are classified plays a role in how taxes are calculated.
Reporting and Paying Taxes on Commissions
For Employees
A commission payment to an employee is handled the same way as a salary payment. The employer withholds an estimated tax amount due based on the entries the employee makes on Form W-4. The total amount paid will be reported by the employer on Form W-2 at the end of the year.
For Independent Contractors
An independent contractor is not an employee but has agreed to perform work for the company.
In this case, the individual, not the company, is responsible for remitting the taxes to the federal government and, if applicable, the state tax authorities. Like most self-employed individuals, they are required to file quarterly, since no one else is withholding taxes for them.
Self-employed individuals use Form 1040-ES: Estimated Tax for Individuals for this quarterly filing.
The taxes due will include income tax, Social Security tax, and Medicare tax.
For annual returns, independent contractors can use the information contained on Form 1099-NEC: Nonemployee Compensation, which is provided to them by the company (or companies) that paid them commissions during the year.
The IRS’s Publication 505 provides details on tax withholding and estimated taxes.
Self-Employment Tax Rate
For self-employed earners, the IRS combines Social Security and Medicare (FICA) taxes into one “self-employment tax.”
The self-employment tax for 2024 and 2025 is 15.3% (including 12.4% for Social Security and 2.9% for Medicare.
Calculating Taxes on Commissions
Taxes on commissions can be calculated in either of two ways, depending on the filing status of the individual who receives them.
If the individual is an employee and commissions paid are included in regular wages, the employer will calculate and withhold the taxes according to the employee’s W-4 information and the tax withholding table in IRS Publication 15-T, Federal Income Tax Withholding Methods.
If the commission is paid separately as a supplemental wage, an employer has two ways to determine the taxes withheld: the percentage method or the aggregate method.
Percentage vs. Aggregate Calculation
The percentage method is a flat 22% tax rate up to $1 million. If the commission is more than $1 million, the withholding rate is 37% for 2024 and 2025.
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 you are an employee, and it is included in your regular pay, the money 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, it’s considered to be a supplemental wage and is taxed at the 22% rate.
Employers must also withhold Social Security and Medicare taxes from supplemental wages.
What Is a Supplemental Wage?
The Internal Revenue Service defines supplemental wages as payments made to an employee that are not regular wages. They can 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, your employer in most cases is required to pay you any 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.
Payments of commissions following a termination 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 is supplemental to their salary, the employer is responsible for paying the withholding taxes directly to the IRS.
If an employee is self-employed, and therefore an independent contractor, the individual is responsible for paying the taxes directly.
