Paying and Deducting Commissions to Employees
Commissions to Independent Contractors and Employees
Paying commissions to employees is sometimes difficult because there are different kinds of commissions and different ways commissions can be paid to employees.
A commission is any payment made to an employee, independent contractor, or agent, based on performance. Some examples of commissions:
- A 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.
- An 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 also receive commissions on the sale of a property. Typically these agents are not employees of a company.
How Commissions Are Paid and If They Are Taxable
Commissions to Employees. Commissions are usually paid to employees in their paycheck or a separate paycheck, at the time and method specified by the employer. 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.
Commissions to Non-employees. 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.
How Commissions Are Reported for Tax Purposes
Commissions to employees are reported on the employee's W-2 form, in Box 1: Wages, tips, other compensation.
Commissions to non-employees are reported on the 1099-MISC forms in Box 7, Non-employee Compensation.
In both cases, the commission income is included with other income on the person's income tax return. in the case of the employee, commissions are included when FICA tax (Social Security and Medicare) is calculated. In the case of the non-employee, no FICA tax is calculated, but if the person is self-employed, the commission income is included when calculating self-employment taxes.
How Commissions Work in Retail Businesses
Employees in retail establishments who are paid commissions may be exempt from overtime under a special Section 7(i) overtime exemption. According to the Department of Labor, a retail employee who meets all three of the following criteria may be considered exempt from overtime. If the employee doesn't meet all three criteria, overtime must be paid to this employee. The criteria are:
*the employee must be employed by a retail or service establishment, and
*the employee's regular rate of pay must exceed one and one-half times the applicable minimum wage for every hour worked in a workweek in which overtime hours are worked, and
*more than half the employee's total earnings in a representative period must consist of commissions.
Deducting Commissions You Pay to Others
You (as a business owner) may deduct commissions and fees paid to employees and independent contractors for their services. For example, if you paid a broker a commission to help you buy a business, this commission is deductible as a business expense. Or if you paid a finder's fee to someone for finding you a business to buy, you may also deduct this amount.
Where to Show Deductions for Commissions Paid 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.
For More Information on Paying Commissions, the Department of Labor's Wage and Hour Commission has a Fact Sheet on Commissions.
This article presents general information for the purpose; I am not a tax attorney or tax preparation specialist. Refer to IRS publications and refer questions to your tax consultant.