How is commission taxed?
Find out the various ways in which the IRS taxes commission and supplementary income.
Commission tax is a tax that is applied to supplemental income, such as bonus pay, severance pay, or pay that is received for freelance work.
The IRS views all commission-based wages as supplemental income.
Commission for employees is taxed differently from commission for self-employed professionals.
Cultivating up-to-date knowledge about commission tax can help you organize your tax affairs more effectively and alleviate unnecessary tax burdens.
A financial advisor can help ensure you’re paying the right amount of tax and help you manage your overall tax liability.
What is commission tax?
Whether you are a self-employed professional or a regular employee, any commission or supplemental income that you earn outside of your standard salary gets taxed by the IRS.
This type of tax is referred to as a commission tax, and just like with a regular paycheck, the IRS has a system for collecting its dues.
Supplemental income is defined as income that you receive in addition to your regular wages. This income can be generated by independent contractor work you outsource to other clients, freelance or gig work, or bonuses you receive from your employer. It can also include severance pay, back pay, and overtime pay.
The IRS and tax on commission
The IRS views commissions in the same category as supplemental income, and from their perspective, any income, including supplemental income, must be taxed.
The way in which your commissions or supplemental income are taxed will depend on the structure chosen by your employer or client.
It also depends on what your relationship is with the commission sender. Full-time employees, part-time employees, and independent contractors all have unique commission tax structures set by the IRS.
How is commission taxed for employees?
All employees are taxed on their commission earnings, but the percentage rates fluctuate depending on the amounts received and the type of relationship shared between employee and employer.
With the percentage method, employers hold a 22% tax rate on commissions below $1 million.
If the commission is above $1 million, the tax rate increases from 22% to 37%.
These rates exist so that employees’ earnings can still be taxed without reducing the income value too much.
So, how much is commission taxed? Let’s look at the following example:
If you earned $5,000 worth of commission in the form of severance pay or an end-of-year bonus, your employer would retain $1,100 for taxes, leaving you with $3,900.
How is commission taxed for independent contractors?
The commission tax structure for independent contractors, freelancers, and other self-employed professionals differs from that of regular employees.
If you fall into any of the former categories, you are responsible for filing your own income taxes – and with most, if not all, income being classified as commission or supplemental income by the IRS, your wages will be subject to the self-employment tax percentage of 15.3%.
That 15.3% includes a 13.4% tax for Social Security and a 2.9% Medicare tax.
Additionally, regular income tax rates and localized state taxes will also apply. It is considered standard for self-employed professionals to pay commission tax every quarter.
Find an expert financial advisor
Whether you are a regular employee with a standard income structure or a freelancer who exclusively earns via commission from a broader client base, understanding how commission gets taxed is an important part of managing your income.
It’s also important to note that commission tax applies to all types of income outside of regular employer-employee wages, including severance pay, bonuses, and income earned from side gigs or self-employed work. Even if you have a small side hustle, you need to understand your tax obligations.
Once you understand how commission tax works, it can become a lot easier to meet your annual tax deadlines in the legally required way and avoid unnecessary penalties.
A financial advisor can help you take charge of your finances and ensure your taxes are always correct and up-to-date. If you want help managing your taxes, let Unbiased match you with an expert SEC-regulated financial advisor.
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