Commission Income: Definition, Types, Pros & Cons

Have you ever wondered what it means to earn commission income? Does it work differently compared to an average employee’s wages or regular pay? 

You may have even earned a certain amount of compensation in the past for a job you have done. But what’s the actual difference between a commission income amount and regular wages? The answer is that it all depends on certain factors.

These factors are important to consider when it comes to commission wages. That’s why we created this guide. Keep reading to learn everything you need to know about commission income.

Table of Contents

What Is Commission Income?

Types of Commission Income

How to Calculate Commission

Taxes on Commission Income

What are the Advantages and Disadvantages of Commission?

Examples of Commission Income

Key Takeaways

Frequently Asked Questions

What Is Commission Income?

An employee receives a commission income in exchange for making a sale. It can be common for employees to earn additional income on top of their base wage or base salary. It is also common for some employees to work solely on commission. It all depends on the type of role. 

For example, if you work in a sales role and make a sale worth $200 and earn a 10% commission, you would earn $20 on that individual transaction. 

There are several important metrics to consider when determining an employee’s commission. These include the amount of sales an employee makes, how frequently they make sales, and how well they perform. 

These elements ensure that employees receive payment according to performance. In turn, this encourages them to sell more goods or services.

A variety of advantages might come with commission-based pay for employees. They may have a better chance of deciding how much money they receive in return. In essence, commission pay doesn’t restrict your employee’s ability to achieve a better salary.

Some of the most common jobs that earn commission include:

• Recruiting
• Real estate agents
• Finance roles
• Sales roles

Types of Commission Income

There can be a broad range of ways to earn commission income. Let’s take a closer look at some of the most common ways.

Salary Plus Commission

Salary plus commission pay means that an employee can earn extra commission in addition to the base salary they earn. Many employees prefer this type of commission structure since there is a guaranteed income. The income comes regardless of how many sales they make.

For example, salary plus commission can be common in merchandise sales. When an employee makes sales, they will earn their regular salary plus commission on each sale that they make. This can lead to a higher earning potential with commission income. 

Earning Straight Commission

A straight commission is when an employee’s only source of income is a commission. An employer calculates straight commission based on how much the employee sells. 

When an employee receives straight commission, they have complete control over their earnings. So, earnings can be substantial if there is no salary cap.

However, a company may experience a slow period at certain times of the year. This directly affects an employee on straight commission. As a result, businesses advise employees to budget their commission payments in order to plan for future spending. 

Straight commission is very common in real estate, where agents receive payment based on the number of houses they sell.

Drawing Against Commission

When a company offers a draw against commission pay, it gives the employee a set amount of money at the start of their employment. We call this sum “the draw”. 

If the employee sells more than this amount, it becomes their income. Everything else is commission. If they do not sell enough, they must return the entire amount to the employer.

Drawing against commission may appear risky. Why? Because there is no guarantee that the employee will earn the same amount of money in sales as stated at the outset. However, many employers use the commission draw as a goal and motivator to sell.

Residual Commission

Any commission earned by an employee after the client makes their first purchase is a “residual commission”. Residual commission pay is particularly common in the real estate and insurance industries. 

Sometimes an employee leaves the company where they earned the residual commission. When this happens, they will continue to receive it if the client stays with the company.

Employees benefit from residual commission pay. This is true mainly because they continue to earn money after their initial interactions with customers. 

This type of commission pay is especially useful when there is no consistent source of income. The employee earns a residual commission from a client’s ongoing payments toward their insurance or home.

How to Calculate Commission

Before getting started calculating commission, there are a few important things to know. Understanding these particulars will allow you to accurately calculate the right amount. Everything from the commission base, rate, period, tier, and split should be considered. 

Let’s take a closer look at the steps to calculate commission. 

• Understand the Commission Period – This relates to monthly, biweekly, or weekly. Typically, commissions are given at the end of a specific period. Your employer will often set this period.
• Determine the Commission Base and Multiply by the Rate – The base is usually the product purchase price. For example, your commission base would be $5,000 if you sell a total value of $5,000. If your commission rate is 10%, you would multiply this by the base. Therefore, the total would be $500. 
• Incorporate Any Commission Rates – Rates can sometimes vary depending on the product. Yet, it’s simple to calculate since you just need to find the commission base and multiply it by the proper rate. 
• If Needed, Use a Tier System – Sometimes a tier system is used in calculating commission. Let’s say you sell $10,000 worth of one product and the first $6,000 is a 5% commission rate. The remainder has a rate of 2%. To calculate, it would look like this: 

($10,000 x 0.05) + ($4,000 x 0.02) = $580 in commission payment 

• If Needed, Calculate Override – What happens when you sell more than an allotted amount? An override might be applied to the original base amount. For example, you might have an 8% commission rate up to $10,000. But, if you sell more than that, the commission rate could rise to 9%.
• If Needed, Split the Commission Between Other People – There can often be more than one team member. This usually happens when several people are involved in a single sale. If four people had $25,000 in sales at a 7% commission rate, you would calculate it the same. However, you would then split the commission four different ways. The calculation would look like this:
  

$25,000 x 0.07 = $1,750 in commission

$1,750 ÷ 4 = $437.50 for each employee

Taxes on Commission Income

You must withhold taxes on commissions as an employer. Payroll and federal income taxes must be withheld.

Commissions are subject to payroll taxes, just like regular wages. Some of the most common taxes include the likes of Social Security and Medicare taxes. These taxes get deducted at a flat rate. 

There are 2 ways to tax commission payments for federal income as supplemental wages. You have the option of using the percentage or aggregate method. If an employee receives a certain amount in supplemental wages, the excess money is then going to be subject to a separate tax rate.

What are the Advantages and Disadvantages of Commission?

Depending on the type of job and the industry, there can be both advantages and disadvantages to earning commission income. Keep reading to learn about some of the main ones to consider.

Advantages

• You can control your own income. Because you are responsible for meeting your monthly or quarterly targets, your success is literally in your own hands. So, if you need to make more money in one month, you’ll know to work harder. In contrast, if you are an older worker looking for supplemental income, you may not need to push yourself as hard.
• Your earning potential can increase. The great thing about some commission-only jobs is that they may not have a salary cap. This means that you can theoretically make as much money as you want. Even if the company does have a commission earnings threshold, you may be able to exceed that amount through other benefits.
• You can gain more independence. Commission-only jobs are primarily a numbers game. If you’re meeting or exceeding your monthly quotas, your boss is unlikely to question how you’re spending your time. This can be very appealing to someone who prefers to work without much interference or supervision from a boss or manager.

Disadvantages

Some of the main disadvantages to earning commission income can include:

• Having your income fluctuate from week to week or month to month, leading to higher or lower federal income tax.
• Some employers or financial institutions might view you as a high-risk worker.
• It could lead to a higher turnover rate for the job that you’re currently in.
• There is a need to be highly self-disciplined.
• You need to know how to balance the stress and difficulty that come with working remotely, depending on the role.

Examples of Commission Income

As one example of commission income, let’s say that two salespeople are working together as a team. They have a goal of reaching $50,000 in sales for the month. If they reach this target, they will each earn a 6% commission. If they exceed this sales amount, any sales above $50,000 would be subject to 7% commission. 

The team ended up having a total of $62,000 in sales, exceeding their target. To calculate their commission using a tier system, it would look like this:

$50,000 x 0.06 = $3,000 in total commission 

$3,000 ÷ 2 sales people = $1,500

$12,000 x 0.07 = $840

$840 ÷ 2 = $420

$1,500 + $420 = $1,920

Therefore, each salesperson would earn $1,920 in commission from the $62,000 in total sales. 

Another easy example of commission income is in real estate. A real estate company closes a deal on a property worth $500,000 at a 5% commission rate. In this case, the company would earn a commission income of $25,000.

$500,000 x 0.05 = $25,000

Key Takeaways

Earning commission income compared to regular wages paid can bring a range of benefits. Yet there can be a lot to know as an employer when it comes to different income accounts. 

There are several different commission types to familiarize yourself with. These include residual income, straight commission, and salary plus commission.

It’s important to understand how to calculate commission income. This process will work differently compared to an employee’s regular wages.

There are certain commission rules to follow from the Internal Revenue Service (IRS) as a small business owner. Also, commission income earned is still subject to taxes withheld. It’s important to take into consideration things such as overtime pay in regard to total income.

FAQ on Commission Income

Is Commission an Asset or Liability?

Even though commission is technically unearned income, it will show up as a liability on your balance sheet and income accounts.

Is Commission an Indirect Income?

When commission is earned from selling a product or service, it is considered direct income.

What Is the Difference Between Commission and Bonus?

Well, employees earn commission by making sales. The more sales you make, the more commission you can earn. 

On the other hand, a bonus is a lump sum payment that you receive in return for reaching a sales target or in return for performance. This typically happens at the end of a month or a year. If you make 49 sales in a year instead of 40, your commission will rise dramatically. But your end-of-year bonus might stay the same.

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