How is commission income taxed?
Salesmen live off the money they make from the sale of a product. Some companies pay a small hourly wage or salary to compensate for slow times.
A salesman may look at a paycheck and wonder about the difference between what is withheld from his salary portion of pay versus the commission portion of his wages. At first glance it appears that his commission pay is getting taxed at a higher rate, however, that is not the case.
Wages and Withholding
The calculation for what amount to withhold from an employee's paycheck is based on what the annual salary would be based on hourly pay. The tax tables for that tax year are used to calculate the amount of taxes that would be owed at the end of the year.
Once this figure is reached, deductions are made based on the number of exemptions being claimed by the employee. These exemptions could be in the form of dependents or in specific circumstances that allow additional exemptions.
Wages and FICA Contributions
For the wages portion of the income, the employee contributes 6.2 per cent from his gross earnings and the employer contributes the other 6.2 per cent portion to complete the Social Security portion of the taxes. Another 1.45 per cent is contributed from employee earnings with an additional employer contribution of the 1.45 per cent for the Medicare portion of the FICA taxes.
Commissions and FICA
For commissions, the percentages for Social Security and Medicare do not change.
The tax is the same percentage as wages or salary earned. These are amounts that cannot be manipulated or decreased except by reducing the number of hours worked and thereby reducing the gross pay.
Commissions and Withholding
Here is where the confusion comes in. A lot depends on how your employer chooses to handle commission payments. Some employers choose to withhold from commission pay at a flat rate of 25 per cent. This is the same way many companies handle the payment of bonuses or incentive pay.
Ostensibly this is to anticipate the commissions received pushing the employee into a higher tax bracket. Because the salary withholding is more often than not closer to a 15 per cent tax bracket, some salesmen are left scratching their heads on payday.
Commissions and Withholding versus Being Taxed.
While the rate of withholding is going to be higher, all income is going to be taxed at the same rate at the end of the year.
What is being done is really to your benefit as a salesman, so that if due to an outstanding record in sales you do progress to the next tax bracket, you will be more ready with the larger amounts being set aside for taxes. If you don't, then it will more than likely end up in your receiving a refund of the excess amounts of withholding taken from you.
In short the answer to this question is that commission is taxed in the exact same way that salary and wages are taxed. It's the higher withholding that throws some people off.