Commission can be a great source of income on top of your reasonable regular wages. But, just like every other income stream, commission must be taxed. Keep reading to learn what qualifies as taxable commission and how your employer calculates taxes on your commission payments.
What does the IRS consider commission payments?
The IRS considers commission a “supplemental wage,” or wages given to employees outside their regular wages. A bonus check, compensation for overtime, back pay, severance pay, awards or prizes, and payments for nondeductible moving expenses are just a few examples of supplemental wages. The method chosen for taxation depends on whether your employer withholds taxes from regular pay and how your commission and regular wages are paid to you.
How is commission taxed?
In a typical salaried position, employers handle tax withholding, but this responsibility may differ for commission-based workers. Depending on whether you are classified as an employee or independent contractor, your tax obligations can vary. Also, how commissions are categorized can impact tax calculations.
For employees
If you earn commissions as part of your compensation, you’ll be treated similarly to an employee who receives a regular salary. This means that your employer is responsible for withholding taxes from your earnings, including those commissions. The amount that gets withheld from your paycheck will depend on what you selected on your Form W-4. When the year wraps up, your employer will report your total earnings, including your commissions, on Form W-2.
For independent contractors
As an independent contractor, you have the freedom of being self-employed, but that also means you’re in charge of your own tax payments. Unlike regular employees, no taxes are withheld from your earnings. You’ll want to make quarterly estimated payments using Form 1040-ES to cover your income, Social Security, and Medicare taxes.
At the end of the year, you’ll need to report your earnings on Form 1099-NEC, which shows the non-employee compensation you’ve received from companies. If any of your income is classified as commission by the IRS, remember that those wages will be subject to a self-employment tax of 15.3%. This 15.3% includes a 12.4% tax for Social Security and a 2.9% Medicare tax.
How to calculate taxes on commission payments
A few scenarios determine how much will be withheld from your commission. If your supplemental income is included in your regular pay, with unspecified payment amounts for each type of income, it’s taxed as a single payment for a regular payroll period.
If your employer withholds taxes from your regular income, and your commission is paid separately from your regular pay – or is combined with regular pay, but the amounts are individually listed – your employer can choose one of the following ways of withholding. The first is the percentage approach, where your employer withholds a flat 22% tax on your commission earnings. The second method, the aggregate approach, requires your employer to complete a few additional steps:
- If supplemental wages are paid at the same time as regular wages, your employer will add regular and supplemental wages together. The IRS states that if there are no wages paid at the same time as the supplemental pay, your employer must add your supplemental pay to the regular wages already paid, those paid for the current payroll period, or to wages paid in the preceding payroll period.
- Your employer must calculate your income tax withholding rate as if the total of the regular and supplemental funds are a combined single payment using your adjustments claimed on Form W-4 with IRS Publication 15.
- Your employer will find the taxable amount for the regular wages only.
- Your employer will subtract the taxes withheld from the regular wages.
- Lastly, your employer will withhold any remaining taxes from your supplemental wages using Step 4 on Form W-4.
What if my employer didn’t withhold taxes from my regular wages?
If your employer hasn’t withheld taxes from your regular wages this year or within the last calendar year, they could still use the aggregate approach. This means they combine your supplemental pay with your regular wages and withhold taxes as if it were a single payment.
Why is commission taxed higher than other income?
Supplemental income, like commission, is taxed differently and often at a higher rate than regular salary because it’s considered additional earnings above your base pay. Since it can vary widely from pay period to pay period, the IRS treats it as a separate type of income. To ensure enough tax is withheld upfront, commission is typically taxed at a flat 22% federal rate or higher withholding. This helps prevent underpayment when you file your taxes.
How does commission affect your tax bracket?
Commission can affect your tax bracket because it increases your total taxable income for the year. While earning commission alone doesn’t automatically push you into a higher bracket, a large bonus or high commission year could raise your overall income enough that part of it is taxed at a higher rate. You typically won’t know for sure whether you’ve crossed into a new bracket until you file your tax return. If your income jumps significantly, it may be a good idea to review your withholding, adjust estimated payments, or set aside additional savings.
Is payroll tax applied to commissions?
Regardless of the method your employer uses to withhold income taxes on your supplemental wages, they are still required to withhold payroll taxes (to cover Social Security and Medicare) from your supplemental wages as well.
Commissions are often classified as supplemental income and are subject to withholding for federal income tax, Social Security, and Medicare taxes. At the federal level, commissions are usually taxed at a flat rate or according to the employee’s withholding allowances. Individual states may impose their own income taxes on commissions.
