A salaried person is an employee who is paid through her employer's payroll system. A worker paid on commission may be an employee or an independent contractor. The similarities and differences between salary and commission income are also reflected in the way workers are taxed.
If you are paid only salary, federal income tax is withheld according to your taxable salary and the filing status and number of allowances you claim on your W-4 form. Generally, the withholding amount, which your employer obtains from the Internal Revenue Service Circular E, stays the same unless your salary or deductions change.
Salary Plus Commission of $1 Million or Less
When you receive salary and commission of $1 million or less, federal income tax is withheld according to whether the payment is made separately or together. If the employer combines salary with commission, without identifying the amount of each, regular salary withholding rates apply. If the commission is paid, and identified, separately from salary, federal income tax may be withheld at 25 percent. The employer can use the 25 percent withholding rate only if you earned regular wages, from which federal income tax was withheld in the current or preceding calendar year.
Salary Plus Commission of More Than $1 Million
When salary and commission equal more than $1 million, the amount over $1 million is taxed at the highest income tax bracket for the year, which is 39.6 percent as of the date of publication.
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Taxation on Only Commission
If you receive straight commission, your employer cannot use the 25 percent withholding method because you did not earn any regular wages from which taxes were withheld. To calculate the withholding, your employer must use the aggregate method by establishing a payroll period and withholding federal income tax based on the ordinary withholding rates for that payroll period.
Employers are responsible for submitting employees' withholding to taxation agencies. If you're an independent contractor who receives only commissions, you must handle your own payments. Employers report salary and commission income plus taxes withheld on employees' annual W-2. The contracting party provides the independent contractor a 1099-MISC form, which shows annual commission payments and no taxes withheld.
Social Security and Medicare taxes must come out of salary and commission earnings. Employers must withhold these taxes from your paychecks, if you're an employee. If you're an independent contractor, you must account for them on your own, typically via estimated quarterly tax payments and annual filing. Some states set their own income tax rate for commissions, while others adopt federal withholding guidelines.
At tax time, salaried employees may qualify for a limited number of deductions for job-related expenses, including auto and travel, home office, job hunting, union dues and uniforms. Self-employed commission workers are entitled to even more deductions. Expenses for business operations, meals and entertainment, taxes and interest, charitable contributions, medical and dental insurance, travel and transportation, telephone, repairs and maintenance, advertising and promotion, equipment and supplies, long-term assets and theft and casualty losses are just some of the deductions that may be available to you if you're a commission-only worker. Deductions, whether being claimed by an employee or contractor, are subject to specific rules and limitations.