Tax Benefits of Earning Sales Commissions Rather Than Salary
As the saying goes, two things are certain in life: death and taxes. Ordinary income such as salary or commission is subject to employment taxes. If you earn income, you are subject to taxes whether you earn a commission, a salary or a combination of both. There are no tax benefits in earning sales commissions rather than salary. In fact, the tax rate for commissions may be higher than the tax rate for a salary, depending on how much you earn in commissions.
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Income Taxes
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An employee's pay is subject to federal income tax, Medicare tax, Social Security tax, and state and local taxes if applicable. Together, the Medicare and Social Security tax composes the Federal Income Contribution Act tax, or FICA. The Social Security tax is 6.2 percent up to $106,800 of earnings. There is no income threshold for the Medicare tax rate of 1.45 percent. Employers use ordinary income tax rates published by the U.S. Internal Revenue Service, or IRS, based on the number of exemptions you claim on income tax Form W-4, the Employee's Withholding Certificate and payroll frequency. For example, if you receive a weekly paycheck and earn more than $704 but not more than $1,648, as a single taxpayer, your employer must withhold $91.40 plus 25 percent of your estimated federal income tax from your paycheck.
Salary vs. Commission
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The IRS considers both salary and commission as ordinary income subject to employment taxes. commission earning have no tax advantage. If your commission is less than $1 million for the calendar year, your employer has a choice of applying a flat tax rate of 25 percent or adding your commission to your salary and applying ordinary tax rates using an aggregate method. To apply the flat tax rate, your employer must withhold income tax from your regular pay during the same calendar year you received the commission or the preceding calendar year, and the commission must be separate from your regular income.
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Commission Over $1 Million
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According to federal tax rules, commissions over $1 million for the calendar year are subject to a mandatory flat tax rate of 35 percent. The tax rate may be higher on any commission that causes your total commissions in the calendar year to exceed $1 million.
Filing Taxes
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Whether you receive a commission or salary, the key to your liability at tax time is whether your employer withheld sufficient taxes from your pay during the calendar year. Having too little income tax withheld from your pay exposes you to the risk of a tax liability when you file your tax return. This is particularly true if you do not have itemized deductions using Form 1040, Schedule A. In this case, you must claim the standard deduction or the dollar amount the IRS allows you to deduct from your taxable income based on your filing status.
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References
- Lorman Education Services; "IRS Provides Guidance on Proper Income Tax Withholding for Nine Common Supplemental Wage Payment Scenarios"; G.J. Macdonnell and William Weisman; June 2008
- U.S. Internal Revenu Service: Tax Withholding
- Bankrate.com: Recovering Excess FICA Payments
- EyesOnSales; "Salary or Salary + Commission"; Frank Rumbauskas; November 2010
Resources
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