Are Commissions Taxable? How This Income Is Taxed

Commission-based pay is a common method of compensation in many industries. If you earn this type of income, you must understand its tax implications. The Internal Revenue Service (IRS) has specific guidelines for how this money is treated, which affects both employees and independent contractors.

The Tax Treatment of Commission Income

The IRS views all commissions as taxable income, similar to regular salaries and wages. The IRS categorizes commissions as “supplemental wages,” which are payments made to an employee outside of their regular pay. This category also includes compensation like bonuses, overtime, and severance pay.

Because commissions are treated as wages, they are subject to federal income tax, Social Security and Medicare taxes (FICA), and applicable state and local income taxes. The amount of tax withheld can depend on how your employer pays it.

Tax Withholding for Employees

For W-2 employees, employers are required to withhold taxes from commission payments. The IRS provides employers with two main methods for this: the Percentage Method and the Aggregate Method.

The Percentage Method is used when commission is paid separately from regular wages. Under this approach, the employer withholds a flat 22% on supplemental wages up to $1 million for the year. For example, on a $5,000 commission, the employer would withhold $1,100 for federal income tax. Any supplemental wages exceeding the $1 million threshold are subject to a 37% withholding rate.

Alternatively, an employer can use the Aggregate Method. This involves combining the commission payment with the employee’s regular wages for a payroll period. The employer then calculates the income tax withholding on the total amount based on the information on the employee’s Form W-4.

Tax Obligations for Independent Contractors

Individuals who earn commissions as independent contractors have different tax responsibilities. A company does not withhold taxes when paying a commission to a contractor, so the responsibility for calculating and paying taxes falls on the contractor.

Because no taxes are withheld, independent contractors must pay self-employment tax. This tax covers both the employee and employer portions of Social Security and Medicare taxes, as there is no employer to contribute a matching share.

To meet these obligations and avoid penalties, contractors make estimated tax payments to the IRS throughout the year. These payments cover both income tax and self-employment tax and are made quarterly using Form 1040-ES, Estimated Tax for Individuals.

Reporting Commissions on Your Tax Return

The process for reporting commission income depends on your employment classification. For employees, commission earnings are included with regular wages in the total figure reported in Box 1 of Form W-2, Wage and Tax Statement. Your employer provides this document to use when filing your tax return.

Independent contractors receive a Form 1099-NEC, Nonemployee Compensation, from each client that paid them $600 or more during the year. The contractor reports this gross income on Schedule C (Form 1040), Profit or Loss from Business.

When filing Schedule C, independent contractors can subtract the costs of ordinary and necessary business expenses from their gross commission income. This could include expenses for a home office, vehicle mileage, or supplies. These deductions lower the net business income, which reduces the amount of income and self-employment tax owed.