Do You Pay Tax on Commission? Here’s How It Works

Commission income, compensation earned based on sales or performance, is generally subject to taxation, whether received as an employee or independent contractor. Understanding how commission is classified and taxed is an important part of managing your financial obligations. The specific tax treatment of commission depends on various factors, including your employment status and how the payments are structured.

Understanding Commission as Taxable Income

The Internal Revenue Service (IRS) broadly defines gross income as “all income from whatever source derived,” which includes compensation for services such as fees and commissions. This means virtually all income, unless specifically excluded by law, is taxable, and commission income falls within this definition, regardless of employment status. For federal tax purposes, commission is treated similarly to other forms of earned income. It contributes to an individual’s total gross income, which serves as the starting point for calculating tax liability. Consequently, individuals earning commission must account for these payments when preparing their tax returns.

Tax Obligations for Commissioned Employees

For individuals who earn commission as W-2 employees, employers bear the primary responsibility for tax withholding. These employers are required to withhold income tax, Social Security, and Medicare taxes from commission payments, just as they do from regular wages. Commission is often considered “supplemental wages,” which are payments made in addition to an employee’s regular salary or hourly wages.

Employers typically have two main methods for withholding federal income tax on supplemental wages: the aggregate method and the flat percentage method. Under the aggregate method, the employer combines the commission with the employee’s regular wages for a pay period and then calculates withholding based on the total amount using the employee’s Form W-4 information. Alternatively, if the commission is identified separately from regular wages, employers can use the flat rate method, which generally involves withholding federal income tax at a flat rate of 22% for payments up to $1 million.

At the end of each year, employees receive a Form W-2, Wage and Tax Statement, from their employer. This form reports their total wages, including all commission earned, in Box 1, along with the federal income tax, Social Security tax, and Medicare tax that was withheld throughout the year. The amounts reported on the W-2 are then used by the employee to complete their individual income tax return.

Tax Obligations for Commissioned Independent Contractors

Independent contractors who earn commission face different tax responsibilities compared to employees, as they are generally considered self-employed. A primary obligation for these individuals is paying self-employment taxes, which cover both Social Security and Medicare taxes. The self-employment tax rate is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare. This tax applies to net earnings from self-employment of $400 or more.

Since no employer withholds taxes for independent contractors, these individuals are typically responsible for making estimated tax payments throughout the year. These payments are made quarterly to cover income tax, self-employment tax, and any other taxes owed. The due dates for these quarterly payments are generally April 15, June 15, September 15, and January 15 of the following year. Form 1040-ES, Estimated Tax for Individuals, is used to calculate and make these payments.

Independent contractors receive Form 1099-NEC, Nonemployee Compensation, from clients who paid them $600 or more for services during the year. To reduce their taxable commission income, independent contractors can deduct ordinary and necessary business expenses. Common deductible expenses include:

• Home office costs
• Business travel
• Vehicle expenses
• Phone and internet bills
• Business insurance
• Professional supplies

Additionally, independent contractors can deduct one-half of their self-employment tax from their gross income.

Reporting Commission Income on Tax Forms

The method for reporting commission income on your tax return depends on whether you received it as an employee or an independent contractor. For commissioned employees, the total wages, including commission, reported in Box 1 of your Form W-2 are directly entered on Line 1 of your Form 1040, U.S. Individual Income Tax Return. The taxes already withheld by your employer, also shown on your W-2, are accounted for on your Form 1040 to determine any remaining tax due or refund.

For independent contractors, commission income reported on Form 1099-NEC is typically reported on Schedule C, Profit or Loss from Business (Sole Proprietorship), of Form 1040. On Schedule C, you will list your gross commission income and then subtract all your eligible business expenses to arrive at your net profit or loss. This net profit or loss from Schedule C is then transferred to your Form 1040, contributing to your overall adjusted gross income.

In addition to reporting income and expenses on Schedule C, independent contractors must also calculate and report their self-employment tax on Schedule SE, Self-Employment Tax. The net earnings from Schedule C are used as the basis for calculating the self-employment tax on Schedule SE. The calculated self-employment tax from Schedule SE is then reported on Form 1040, and a deduction for one-half of the self-employment tax is taken on Schedule 1 (Additional Income and Adjustments to Income) of Form 1040.