Should you pay taxes on sales commissions?
With election year talk of eliminating income tax on tips, servers, bartenders, and people in other tipped occupations may enjoy tax benefits in 2025 if the “No Tax on Tips” act passes. While this will help many low-income to middle-income workers who rely on tipped income to pay for their daily needs, the legislation ignores another class of workers who often earn money beyond their regular wages: Salespeople who work on commission.
It’s a common question many salespeople ask: “How do tax work with comission pay?”
The answer is easier than you might think. But you’ll need to know how you file and how those commissions are paid. That’s where it gets complicated, especially because salespeople aren’t always employed as W-2 employees, but, instead, may work as 1099 independent contractors.
If you file as self-employed, an S corp, or a C corp, that status can unleash a whole new world of tax deductions, paperwork, regulations, and tax avoidance strategies to understand. You can legally minimize your tax liability and keep more of what you earn. You may want to work with a tax professional who understands how you can reduce your tax bill as an independent contractor, self-employed.
Likewise for commission-based employees who fill out a W-4 form for withholding taxes, understanding taxes on commission pay can be equally confusing. A tax professional can help you sort it all out. Here are the basics.
(Do you file as a 1099 contractor, self-employed or a corporation? Keep reading as we will cover commission-based pay for independent contractors and business owners later in this article!)
How Much Do Salespeople Earn?
Many salespeople in the insurance, automotive, and other industries receive a relatively low base pay for their years of experience and knowledge. That base pay is supplemented with commissions based on sales. Unlike professionals in other jobs, these salespeople are rewarded for their results, rather than paid a flat rate or hourly salary for coming to work.
A career in sales can be risky, but often worth it. If you are good at selling, you can earn far more than you might by working a job with a set salary. According to ZipRecruiter.com, the average commission-based salesperson earns $54,620 per year. The top one percent of salespeople earn up to $92,499 a year.
Of course, this can vary dramatically by industry and region. The average car salesperson in New York can earn up to $170,000 per year, with a starting salary of $97,000 and a median of $127,000, according to GlassDoor.com. Of that, $61,000 to $101,000 is base pay and another $37,000 to $69,000 comes from commissions.
It’s easy to see how that extra income can dramatically affect your tax bill if you are a successful salesperson.
Taxes on Commission for Employees
First, understand this: Commission pay is taxable income and must be reported to the IRS. As of now, no legislation has been introduced to change that law. But how commission is taxed may differ from regular income, depending on how your employer structures your paychecks.
The IRS considers commissions “supplemental income.” Other examples of supplemental income include:
- Performance bonuses
- Overtime
- Backpay
- Severance pay
- Reported tips
- Awards or prizes
- Accumulated sick leave buyouts
Supplemental pay, just like regular income, is subject to withholding tax. If supplemental income is paid separately from your regular pay, your employer can choose one of two methods for calculating withholding: Percentage method or Aggregate method.
The Aggregate Method of Calculating Withholding
Using the aggregate method to calculate withholding tax, your employer would add your commission pay to your regular income, and withhold taxes based on the total amount. Withholding percentages would be determined based on your W-4 election.
If your employer pays your commission as part of your regular income, without differentiating between supplemental and regular income, the aggregate method would also be used to determine withholding taxes.
Taxing commission using the aggregate method could result in getting to keep more of your commission earnings on payday. But you also run the risk of commissions pushing you into a higher tax bracket. If that happens, your withholding tax rate would increase.
The Percentage Method of Calculating Withholding
Alternatively, your employer can choose to calculate withholding based on a flat percentage. The tax rate for supplemental income in 2024 is 22% for commissions under $1 million and 37% on commissions above $1 million.
If your employer withholds taxes at this rate on commissions, you could wind up paying too much throughout the year. That just means you’ll receive a larger tax refund when you file your tax returns.
Do You Pay FICA Taxes on Commission?
Whether your employer uses the percentage method or the aggregate method to calculate withholding on commission-based pay, you must also pay FICA taxes on that income. FICA (Federal Insurance Contributions Act) taxes help fund Social Security and Medicare program. Employers withhold 6.2% of your total gross wages for Social Security and 1.45% for Medicare. The employer also matches that amount for a total contribution of 15.3%.
Taxes on Commission for Independent Contractors, 1099, Self-employed
If you file as an independent contractor, self-employed and receive a W-2 form to show your wages, or if you have a business structured as a corporation through which clients pay you, you must still pay taxes on commissions.
Independent contractors must submit a W-9 form and report all income as it appears on your 1099-NEC (Non-employee compensation). As a self-employed individual, you are responsible for paying both portions of FICA taxes, a total of 15.3%, which is also known as “self-employment tax.”
On top of that, you’ll pay taxes on commission using the aggregate method, which means your commissions are added to your regular income or profits as an independent contractor.
Similarly, if you file as an S corp or a C corp, you will add your commission payments into your regular business income. Business owners who elect to file as an S corp or C corp are not subject to self-employment tax.
FAQ
How do taxes work with comission pay?
Your employer must withhold, and match, FICA taxes from commission pay the same as from a base salary. The employer has a choice of withholding federal taxes from bonus pay at a flat rate of 22% for commissions under $1 million and 37% for commissions over $1 million, or withholding taxes at the same rate as your regular paycheck.
Is commission taxed at 40%?
The federal tax withholding rate for commissions over $1 million is 37%. For commissions under $1 million, employers must withhold 22%. However, when it comes time to file taxes, commissions and bonuses are taxed the same as other income. If your employer is withholding 22% or more for commissions, you might receive a tax refund for overpayment after you file.
Are bonuses taxed the same as commissions?
If you receive a bonus for good performance at work, you will have to pay taxes on that money. The IRS taxes commissions and bonuses as supplemental income
