A commission is money paid to an employee after they do something on your company’s behalf. Most often, commissions are earned by selling products or services.
How are commissions calculated?
Commissions are typically calculated in one of two ways:
- As a percentage of sales made (e.g. you get a 10% commission on sales made so, when you make a sales worth $100, you’ve earned a $10 commission); or
- As a flat amount for each sale (e.g. you get $10 for each sale so, then you sell 3 items, you’ve earned a commission of $30).
Can employees be paid on commission only?
Yes, commissions can totally replace an employee’s salary if certain conditions are met. Under federal rules, these conditions are:
- The employee must perform specific job duties as laid out by the US Department of Labor. These duties need to match actual tasks performed, not just a job title.
- The employee must be paid more than $455 per week. The exception to this rules is outside salespeople who must be engaged in selling products or services or renting spaces and must work away from the office.
If those conditions are not met, then you need to pay the employee minimum wage, and overtime (if applicable). Additionally, you must meet any state and local minimum wage and overtime requirements.
What type of commissions arrangements are most common?
The most common commission arrangements include:
- Salary plus commission: In this arrangement, you pay your employee a base salary which they can then supplement by earning commissions.
Pros: The stability that this scenario provides to an employee can go a long way when it comes to retention. In addition, the incentive to earn more will motivate him or her to hustle.
Cons: The downside is that you need to handle two types of pay for one employee and that can make your payroll process a little more complex.
- Commission only: Under this scenario, you only pay your employee when they earn a commission.
Pros: You don’t need to pay your employee unless they’ve earned a commission which typically means that they’ve made a sale. Also, since you’re only paying commissions, your payroll process will be less complex.
Cons: Typically, the commissions you pay in this scenario are higher since this is the only way for your employee to earn money.
- Draw against commission: Under this arrangement, you provide your employee a pay advance at the beginning of the pay period. At the end of the pay period, you pay the employee his or her commissions minus the advance you provided at the beginning.
Pros: This scenario provides some stability to your commission only employees and that can lead to higher retention.
Cons: This arrangement is riskier than the others since, if an employee does not earn enough commissions to cover the advance over a pay period, you’ll be out money and your employee will be in debt to you. Also, this scenario will make your payroll process more complex.
- Residual commission: In this scenario, you pay a commission to your employee every time an existing customer buys another product or service. This final commission arrangement does not replace any of the three above and can be used together each.
Pros: Under this arrangement, your employees are highly incentivized to stay with your company so that they can continue to earn residuals.
Cons: Paying residual commissions are an ongoing cost to your company. In addition, calculating and including residual commissions will surely make your payroll process more complex.
How are commissions taxed?
The IRS considers commissions to be supplemental wages. This means that they’re taxed differently from regular wages, a fact that can impact paycheck withholdings and end of year filing.
Since proper withholding on commissions can be complicated, it’s best to work with a CPA or use a payroll provider to ensure all those numbers are correct.Updated January 22, 2018
This article provides general information and shouldn’t be construed as tax advice. Since tax rules may change over time and can vary by location and industry, please consult a CPA or tax advisor for advice specific to your business.