For salespeople or other professionals with incentive-based earnings, commissions are king. A strong sales period could result in a big check—only made a bit smaller by tax withholdings.
But first, employers and employees alike should know how commissions are taxed. Here’s how the IRS taxes commissions and how these rules apply to both employees and non-employees, like independent contractors. Plus, find out how to calculate commission taxes and correctly estimate take-home pay.
What is a commission?
A commission is a variable performance-based wage that people earn in incentive-driven compensation methods. Along with this wage, some commission earners also receive a steady (but usually minimal) base salary.
Salespeople, financial professionals, real estate agents, and insurance brokers generally earn commissions. The more they sell, the more they earn, motivating them to achieve top results.
What does the IRS consider a commission payment?
The IRS considers commissions federal taxable income because they’re a type of wage. But the IRS has two different ways of taxing commissions, based on how the employer pays them.
Employers can either disperse commissions as an integral part of an employee’s wages or as supplemental income, similar to a bonus. The employer must then withhold taxes from the employee’s paycheck based on the IRS’s guidelines for integral and supplemental commissions.
Self-employed professionals who earn commissions also pay taxes on them. But without an employer to handle withholdings, independent contractors are responsible for calculating and making tax payments on commissions and all other wages to the IRS on their own.
How much is commission taxed? Key calculations
There are two tax calculation methods for employee commissions, and they depend on how the employer pays these wages.
If an employer includes the commissions in the employee’s regular wages, then the payroll team applies standard withholding methods to the entirety of the paycheck. This is known as the aggregate method. If the employer treats commission-based pay as supplemental (separate) income, they use the percentage method to calculate taxes.
Here’s more on each option.
The aggregate method
In the aggregate method, employers add commissions directly into regular wages and tax the final amount. Employers apply the same standard withholdings as they would to any other paycheck. Then, they forward those retentions to the IRS.
If you’re an employer wondering how to calculate withholding percentages, review employees’ W-4s and the IRS’s most current Publication 15, the Employer’s Tax Guide. An employee’s Form W-4 form shows you their filing status, tax deductions, and withholding preferences, and the IRS’s Publication 15 provides guidance on how to apply and pay taxes.
You’ll also want to view an official copy of the IRS’s updated tax bracket table. This table helps you determine what percentage to withhold from a person’s paycheck based on their total earnings. As a general rule, people with higher incomes pay larger percentages of taxes.
The percentage method
Employers use the percentage method if they pay commissions as supplemental income. A special commission tax rate of 22% currently applies to supplemental income under one million dollars. If an employee earns over one million, the rate jumps to 37%.
How are commissions taxed for employees?
Employers withhold employees’ taxes directly from their paychecks, so they have to calculate and retain taxes on all employee income, including commissions, and pay them to the IRS. The following key considerations about commissions taxation can help you understand the process:
How commissions appear on a Form W-2
On W-2 forms, employers list all income an employee has earned in a year. This document helps employees report their earnings when it’s time to file taxes.
Employers should include commissions in the amount for Box 1 of the form: Wages, Tips, and Other Compensation.
How Form W-4 choices affect withholding
Unless a company pays commissions as supplemental income—which would mean the unique 22% or 37% tax rate applies—then commissions are taxed just like any other earnings. The choices the employee makes on their Form W-4 about deductions or additional withholding amounts apply equally to regular income and commissions.
Payroll taxes: FICA and FUTA
Employees pay two types of payroll taxes out of every paycheck: FICA and FUTA. The Federal Insurance Contributions Act (FICA) mandates retentions for Social Security and Medicare. And the Federal Unemployment Tax Act (FUTA) details withholdings for unemployment tax.
Regular payroll tax withholdings apply to commissions added to standard paychecks. If the company pays commissions as supplemental wages, Medicare and Social Security withholding applies.
How is commission taxed for contractors?
Self-employed professionals, like solo real estate agents, also sometimes receive commissions. Commissions are taxed differently for independent contractors.
In general, taxation—including on commissions—follows distinct processes and rules for self-employed individuals. Here’s what to know about calculating and paying self-employment tax:
Reporting income and paying taxes
Self-employed professionals report their income on Form 1040-ES: Estimated Tax for Individuals and pay estimated quarterly payments to the IRS. After filing their annual tax return, if there’s a discrepancy between the estimated and actual amount owed, the self-employed person will receive a refund or a bill for the difference.
Form 1099-NEC versus Form W-2
At the end of a tax year, employees receive a Form W-2 from their employer showing total earnings. Self-employed folks instead get a 1099-NEC from their clients or other hirers. This is the IRS’s form for non-employee compensation. Independent contractors have to total up the amounts on all of their 1099s to determine their final total income and file taxes accordingly.
Self-employment tax
Self-employed individuals pay federal income tax and state tax, unless they live in a tax-free state. They also pay self-employment tax at a rate of 15.3%, which covers their contributions to Medicare and Social Security.
Contractor deductions
Self-employed people can reduce their tax liability by applying deductions for professional and business expenses. Here are a few of the breaks freelancers can get:
- Start-up deductions
- Home office and office rental deductions
- Insurance deductions
- Business travel deductions
- Education deductions (in academic fields related to the person's line of work)
Stay ahead of taxation changes with Oyster
If you run payroll or work in HR, you know the importance of understanding the tax laws that affect your employees. You also know it’s important to keep your finger on the pulse of changing laws—and new ones that cross your path.
Whether you hire in the US or abroad, Oyster helps you stay up to date. Take the work of becoming a global tax expert off your plate. Oyster’s platform runs globally compliant payroll, complete with accurate tax withholdings and deductions.
FAQ
No one wants to make a costly tax omission or mistake. Here are the answers to some common queries to further your learning.
What is a supplemental wage?
Supplemental wages are additional forms of income beyond an employee’s regular salary or hourly wages. These most often include commissions and bonuses.
Are commissions taxed differently for remote employees working in different countries?
International remote employees are taxed according to the laws in the country where they live and work. That’s because they pay taxes to their local governments.
Working with an Employer of Record (EOR), like Oyster, makes navigating international tax law much easier. Oyster provides a compliant solution to paying employees abroad—without needing to set up a foreign entity.
How do commission payments impact payroll compliance for global teams?
Commission payments are just one more factor that global payroll teams have to consider when staying compliant with foreign tax laws. Employers need to correctly retain taxes on all types of income in adherence to each country’s laws, which is a complex process. Partner with a global compliance expert like Oyster to ease the process.
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
