Earn a Commission? Keep in Mind It Isn’t Always Taxed Like Salary

Most of the people who have a job receive salary and other benefits. However, there are some industries that pay through a commission rather than a salary, and some pay both. How is commission taxed?

A commission is usually tied to the business a person gets for a company and paid as a percentage of the sales that an employee generates. It's used as an incentive to increase worker productivity. The tax filing responsibility isn’t as clear for commissions as it is for salaries.

Commissions are considered “supplemental wages” by the IRS. The agency defines supplemental wages as payments to employees outside of their regular wages. According to the IRS, these payments may include bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, reported tips, retroactive pay increases, and payments for nondeductible moving expenses.

How commissions are taxed and who files them depends on the status of the employee and the way the commissions are classified. If the person who receives a commission is treated the same way as an employee and the commission is included in their regular pay, the employer will withhold taxes in the same way as from a salary. The employer would then remit that information to the IRS, which would tax the commission like ordinary income.

If commissions are identified separately from regular wages, the employer has two ways to determine the way taxes are withheld:

• The percentage method, with a flat 22 percent deduction on commissions. If the supplemental wage payments made to the employee during the calendar year exceed $1 million, the excess is subject to a withholding of 37 percent.

• The aggregate method, which is used when the supplemental wages are paid concurrently with regular wages. The supplemental wages are added to the concurrently paid regular wages and federal income tax is withheld as if the total were a single payment for a regular payroll period.

In the above cases, the employer is required to withhold social security, Medicare, and FUTA taxes.

Another way to treat the individual could be as a self-employed independent contractor. In this case, the employee would be responsible for paying estimated tax payments to the IRS on a quarterly basis. Because this person isn't an employee, no income or FICA tax is withheld. These individuals are subject to self-employment taxes. The individual should file Form 1099-MISC in this case.