A commission is pay based on performance, such as a percentage of sales revenue or the number of units a salesman moves. A bonus is extra pay given for exceptional performance. As far as the Internal Revenue Service is concerned, there's not much tax difference between them.
The IRS classes both bonuses and commissions as supplemental wages. This category covers any payments to employees that are not regular weekly or hourly salary or wages. Bonuses, commissions, overtime, severance pay and retroactive back pay all fall into this category.
Supplemental pay is subject to withholding, just like regular income. The IRS breaks down the ways to do this in Publication 15:
•If the employer lumps bonuses, commissions and regular pay into one lump sum for a given pay period, the company takes out withholding just like it does with regular wages.
•If the company makes two separate payments or identifies separate amounts on the paycheck, it has two options. One is to withhold a flat 25 percent from the bonus or commission pay. The other is to figure out the total withholding for the pay period, subtract the withholding on regular wages and take the rest out of supplemental pay.
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•If an employee's bonus or commission pay tops $1 million in a year, the withholding is at the highest current income tax rate.
When the company issues employees a W-2, it includes bonuses and commissions with regular pay in Box 1. An employee includes both with his income on Form 1040 and pays tax as usual.
One difference between bonuses and commissions is that an employer may pay advance commissions, based on the company's expectations of employee performance. A taxpayer who files a cash-basis return, as most individuals too, must report advance commissions when she receives the money, not when she earns it.
A promise to provide a bonus or commission in the future is never taxable.
Another difference is that where commissions are almost invariably cash, bonuses and awards may be in kind — a stereo, a gift certificate, a trip abroad. The value of these non-cash bonuses is taxable income, and the company reports it in Box 1 of the W-2. The employee pays tax on it as usual.
The IRS makes exceptions if the bonus is based on how many years you've been with the company. Usually that won't count as income, and you don't pay tax on it.