Typically, many workers receive salaries, so no portion of their pay is variable. But some C-suite executives and senior leaders have as much as 60 to 80 percent of their pay tied to performance. Still others, such as those who work in sales, have variable elements in their compensation packages as well. Some of these individuals "work on commission."
But how are those commission payments taxed? And is there a specific commission tax rate?
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What Is a Commission?
A commission is a form of performance-based pay. In the case of a salesperson, a company may assume that the professional will be more committed to the sales process if a large portion of her pay is tied to closed sales. Consequently, it's likely that a large portion of the salesperson's pay will consist of a percentage of the dollar values of the closed sales for which she is responsible.
For instance, a salesperson might earn a 15 percent commission on a $25,000 software implementation sale. Alternatively, the person may receive a certain amount according to a tiered salary schedule that ties certain commissions to different sales volumes.
Commissions Tax Rates
Commission tax rates vary depending on the individual worker, his employment status and other factors. Employers are required to withhold certain taxes, including payroll and federal income taxes, from the paychecks of direct employees who earn commissions and submit those taxes to the appropriate tax authorities. For instance, the federal income tax is forwarded to the Internal Revenue Service (IRS) on behalf of the employee.
If a company's contractor earns a commission, the company pays the individual the entire amount and she is responsible for reporting the pay and submitting the appropriate tax payments to the relevant authorities. In the case of both commissioned and salaried employees, the individual's employment status determines her filing status, the way the company handles the taxes and the commission tax rate.
Treatment of Supplemental Pay
According to the IRS, a commission is supplemental pay, rather than regular wages. Other forms of supplemental wages include overtime pay, bonuses, accrued personal time off and back pay.
The IRS provides employers two unique methods for withholding federal income taxes from supplemental pay, which are unlike that used for salaries: the percentage or aggregate methods. For supplemental pay in excess of $1 million, a commission tax rate must be applied.
Independent Contractor Form 1099-NEC
A self-employed, independent contractor will receive Form 1099-NEC for payments of $600 or more from a contract position. They must submit these with their tax payment to the IRS to report their non-employee compensation. The contractor must also pay FICA taxes, which account for Medicare and Social Security.
In 2021, the self-employment tax rate is 15.3 percent for earnings of $142,800 or less (up to $147,000 for 2022). This percent includes the 12.4 percent Social Security tax rate and the 2.9 percent for the Medicare tax rate.
Read More: What Is Form 1099-NEC?
Salary and Income Tax
As with employees who receive commissions, the salaried worker's employer withholds income tax and other taxes from her paycheck and forwards it to the appropriate authorities. In the case of the salaried employee and the employee who earns a commission, the tax withheld by the employer is influenced by the employee's entries on the Form W-4 such as the person's filing status, dependents, anticipated tax credits and deductions. The employer reports those elections on Form W-2.
Employer and Payroll Taxes
The employer withholds FICA or payroll taxes – Social Security and Medicare taxes – from each direct employee's wages. The FICA tax rate is 7.65 percent in 2021 – 6.2 percent Social Security tax and 1.45 percent Medicare tax. The employer then contributes a matching amount.
Employee Responsibility for Tax Payments
Although one's employee status typically defines the role a worker plays in reporting employment-related taxes, the individual is ultimately responsible for the payment of federal income taxes to the Internal Revenue Service and other tax authorities. Self-employed persons, in particular, may be required to file estimated taxes on a quarterly basis. That responsibility is described in IRS Publication 505.
- Internal Revenue Service: Employer's Supplemental Tax Guide
- Internal Revenue Service: What Is My Filing Status?
- Internal Revenue Service: About Form 1099-Misc
- Zenefits: Your Guide to Self Employment
- Internal Revenue Service: 2021 Form W-4
- Internal Revenue Service: About Form W-2: Wage and Tax Statement
- Internal Revenue Service: Publication 505 (2021) Tax Withholding and Estimated Tax
- Nerdwallet: How FICA Tax and Tax Withholding Work in 202a