Most individuals who have jobs receive a salary from an employer as well as benefits, such as healthcare and retirement accounts (e.g., 401(k) plans). However, some companies, for instance, those in the financial services sector, employ people who work on commission.
Working on commission means that people are paid based on their performance. In this case, an employee might receive a very small salary while the bulk of their income would come from commissions generated from the amount of business they generate for the firm.
The question arises, who is responsible for withholding taxes from commissions?
Key Takeaways
- If an individual is an employee who is 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 appropriate amount of taxes to the tax authorities.
- The taxes on commissions are calculated in different ways, depending on the filing status of an employee.
Understanding Commissions and Tax Withholding
A commission is an amount of money that represents a percentage of the sales value an employee generates for their company.
Compensation by commission is not ideal for everyone. Those who are paid in this manner generally have to be extremely proactive in both, procuring new business and nurturing existing business. They must meet sales targets to make enough money to support themselves.
In a standard salaried job, tax withholding is the responsibility of the employer. This is not always the case for someone working on commission. That's because they may be an employee of the company or they may be an independent contractor who, despite working on behalf of the company, is not employed by it.
The income tax withholding responsibility for someone who earns their living through commissions is different depending on their employment status. In addition, the way in which the commissions are classified also plays a role in how taxes are calculated.
Reporting and Paying Taxes on Commissions
For Employees
An individual who receives commissions can be treated in the same manner as one who receives a straight salary. That is, they can be an employee of the company. In this case, the employer would withhold taxes from the individual's compensation and remit the withheld 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.
For Independent Contractors
Alternatively, the individual can be a self-employed independent contractor, or someone with whom a company contracts to provide services or perform work. This person is not employed by the company.
In this case, the individual and not the company would be responsible for remitting the taxes to the federal and state tax authorities. In fact, normally they are required by the Internal Revenue Service (IRS) to pay taxes quarterly since no one is withholding taxes for them. For this, they should use Form 1040-ES: Estimated Tax for Individuals.
These estimated taxes cover income taxes, Social Security taxes, and Medicare taxes.
Also, independent contractors would file their annual tax return using the information contained on Form 1099-NEC: Nonemployee Compensation which is provided to them by the company (or companies) that paid them commissions.
The IRS's Publication 505 provides details on tax withholding and estimated taxes.
Self-Employment Tax
FICA taxes for Medicare and Social Security are accounted for when the independent contractor files self-employment tax. The self-employment tax rate is 15.3% for 2024, with 12.4% for Social Security and 2.9% for Medicare.
Calculating Taxes on Commissions
Taxes on commissions are calculated in different 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, then 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%. However, if the commission is more than $1 million, the percentage is 37% for withholding in 2024.
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, 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 bystate.
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, then the individual is responsible for paying the taxes directly.
