Paying commissions to employees is sometimes difficult because there are different kinds of commissions and different ways they can be paid. Here is what you need to know about paying commissions, deducting them as a business expense, and recording them for employment tax purposes.
What Is a Commission?
The U.S. Department of Labor defines a sales commission as a sum of money paid to an employee when a task is completed, usually selling a certain amount of goods and services. Commissions can also be paid as incentives to increase worker productivity.
Some examples of commissions:
- Sales Employee: May receive a sales commission, usually in addition to base pay, for meeting or exceeding a specific sales target in a specific period of time. This commission may be a percentage of sales or a percentage of a base amount of sales.
- Insurance Agent: Typically, an independent agent or non-employee agent makes a commission on the sale of an insurance policy. The amount of commission varies based on the type and amount of the policy.
- Real Estate Agents: Receive commissions on the sale of a property. Typically, these agents are not employees of a company.
Commissions and Taxes
Commissions are always taxable income to the person receiving them, both employees and non-employees.
Commissions are a cost of doing business, so if they are "ordinary and necessary" expenses they are usually deductible to your business.
Commissions Taxable to Employees
Commissions paid to employees are considered supplemental wages because they can be included in the employee's regular paycheck or paid separately. They may be paid as a percentage of total sales or in excess of a specific amount, or some other method.
Commissions are considered part of the regular pay for an employee and they are taxable. That means federal and state income taxes and FICA taxes must be withheld from commission checks, and you as the employer must pay part of these taxes.
Withholding taxes on supplemental wages must be done in specific ways, depending on whether the payment is part of the employee's regular paycheck or is a separate payment. See this article on Supplemental Wages for more information.
Commissions for Overtime and Retail Employees
If you are paying commissions to retail employees, you may be able to elect an exemption from paying overtime to these employees. To get this exemption:
- The employee must be employed at a retail or service business
- The employee's regular pay rate must be greater than one and one-half the minimum wage for every hour worked in a workweek in which overtime hours are worked
- More than half the employee's total earnings in a period must be from commissions
If all three conditions aren't met, you must pay overtime premium pay (at least one and one-half the employee's regular pay rate) for all hours worked over 40 in a workweek.
How to Report Commissions for Tax Purposes
Reporting Employee Commissions: Commissions to employees are reported on the employee's W-2 form in Box 1: Wages, tips, other compensation. You must file a copy of the W-2 with the Social Security Administration and give a copy to the employee to do their taxes.
You must also include commissions as employee income on Form 941, your quarterly payroll tax report, and make periodic payments of these taxes to the IRS.
Reporting Non-Employee Commissions. Commissions paid to non-employees (agents and independent contractors, for example) are paid directly to the worker. Because this person is not an employee, no income tax or FICA tax is withheld. These workers are considered self-employed and the payments you give them are subject to self-employment taxes on these payments.
If a non-employee is subject to backup withholding, you must include commission payments to that person when you are calculating the backup withholding amount.
You must report commission payments to non-employees on IRS Form 1099-NEC (beginning in 2020), and you must give a copy of this form to both the payee and the IRS.
Deducting Commissions Payments
You (as a business owner) may deduct commissions and fees paid to employees and independent contractors for their services.
- Commissions, bonuses, or fees to get a lease on business property
- Commissions for getting a mortgage on a business building
- Commissions for issuing and selling stock or securities
Where to Show Deductions on Your Business Tax Return
If you have paid commissions to others, you can deduct these expenses in specific places on your business tax return. The place where you enter the deduction depends on your business type:
- For sole proprietors and single-member LLCs, commissions and fees are totaled on the "Expenses" section of Schedule C
- For partnerships and multiple-member LLCs, commissions and fees are totaled in the "Deductions" section of Form 1065
- For corporations, commissions and fees are totaled on the "Deductions" section of Form 1120