Most people who work for a living get a salary as well as benefits such as healthcare and retirement accounts such as 401(k) plans. Certain businesses, notably those in the financial services industry, pay on commission. This implies they get compensated depending on their performance. In this situation, an employee would be paid a relatively minimal wage, with the majority of their income coming from commission on the amount of business they bring in for the company.
- If an employee receives commissions from his or her employer, the company withholds taxes and pays the IRS.
- If the person is self-employed or an independent contractor, he or she is responsible for remitting taxes to the appropriate authorities.
- The taxes on commission will be computed differently depending on the employee’s filing status.
Understanding Pay by Commission and Tax Withholding
Commission compensation is not suitable for everyone. Those engaged in this capacity must typically be exceedingly active in acquiring new business and keeping current business in order to meet sales objectives and earn enough commission to sustain themselves financially. A commission is often paid as a proportion of the sales value generated by an employee.
Tax deductions are the obligation of the employer in a regular paid position. This is not always the case for a commission-based employee. The duty for reporting income taxes for an employee who makes a livelihood via commission varies based on their work status. Furthermore, the manner in which commissions are categorised influences how taxes are computed.
Reporting Taxes on Commission
Individuals who get commissions may be treated the same as those who receive a straight wage. In such instance, the employer would deduct taxes from the employee’s pay and send the money to the tax authorities on the employee’s behalf. The withholding would be based on the elections made by the employee on Form W-4 and reported by the employer on Form W-2 at the end of the year.
Alternatively, the person may be considered as a self-employed independent contractor, with the responsibility of remitting taxes to the tax authorities themselves by filling out Form 1099-MISC, which denotes non-employee remuneration.
FICA taxes are not included in this category and must be reported when the employee files self-employment taxes. Medicare and Social Security are covered by the self-employment tax. The current self-employment tax rate is 15.3%, with 12.4% going to Social Security and 2.9% going to Medicare.
As most Americans are aware, each taxpayer is ultimately responsible for paying their income taxes to the Internal Revenue Service (IRS) and state tax authorities. Self-employed persons who earn commission may be required to pay quarterly estimated taxes. Publication 505 of the IRS explains tax withholding and anticipated taxes.
Calculating Taxes on Commission
The taxes on commission will be computed differently depending on the employee’s filing status. If the person is classified as an employee rather than an independent contractor, the employer will withhold taxes in the usual manner if the commission is included in regular earnings.
If the commission is paid as a distinct supplementary salary, the employer has two options for calculating the taxes withheld: the percentage approach or the aggregate method.
The percentage technique is a 22% flat percentage discount on commissions. However, if the commission exceeds $1 million, the amount withheld in 2020 is 37%. The aggregate technique entails summing the commission and regular pay, designating the total as regular wages, and withholding taxes at ordinary income tax rates.
Crystal Brook Advisors, New York, NY, Peter J. Creedon, CFP®, ChFC®, CLU®
The actual issue is whether the individual is an employee or an independent contractor. If you are an employee, it is up to your state’s employment laws to determine who is liable for withholding taxes on any income. If they are an independent contractor, they must pay their own taxes.
Employers must use caution when referring to their employees as independent contractors when they are effectively performing employee tasks. If the employment needs regular hours and reporting to a boss, is open-ended (has no end date), and does not provide any genuine autonomy in how or whether to work, the individual is likely to be classified as an employee. For judging them independent, the employer may be held accountable for benefits, overtime, taxes, and penalties by the federal or state Departments of Labor.
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