4 Factors to Consider When Running Payroll for Commissioned Employees
Many employees whose jobs fall into the sales category are typically paid some sort of commission rate. Running payroll for these employees can involve some complex calculations, which is why it’s important that you find a payroll software that makes this process as simple as possible for you. If you’re new to processing payroll that involves commission, it’s important that you’re familiar with how it works. Commissions are typically based on a percentage of the total sales with the idea that the more sales that are made, the more money that goes into the employee’s pocket. Most commission-based jobs have a base salary, too, making calculations a little more complex.
Here is an example of how this process might work:
Say your sales employees get a straight commission of 15% and one makes a sale for $10,000. By using the equation Total Amount Sold x Commission Percentage the gross pay for this employee on this sale is $1,500. (10,000 x 0.15 = 1,500)
Base Salary
Typically there is an inverse relationship between the commission rate of a sales employee and their base salary. That is to say, somebody with a fairly sizable base salary is likely to have a much lower commission rate. This might allow the employee some comfort knowing she has a decent paycheck guaranteed each pay period but will often provide her with less monetary compensation than someone who has a higher commission, particularly during the busy months.
For example:
Salesperson A receives a base salary of $1,500 each month, with a 4% commission on everything he sells during that time. If he sells $45,000 worth of product, his commission for the month would be $1,800. Add that to his $1,500 base salary and he receives a paycheck that amounts to a gross pay of $3,300.
Salesperson B receives no base salary, but is allowed a 10% commission rate on all products sold each month. If she, too, sells $45,000, her paycheck will equal a gross pay of $4,500 for the month.
In the example above, it’s clear that Salesperson B makes off with more money. However, if she ever comes across a dry spell for business, her pay will drop significantly and there will be no base salary to fall back on. It’s very “high risk, high reward” and you’ll want to consider all aspects of each method before deciding how to pay your salespeople. Having no base salary certainly incentivizes them to work harder and more passionately, but one bad month can often lead to one of your employees to jump ship. After all, it’s important to have some semblance of financial security with your job, and sometimes no matter how hard somebody might work to make sales, it ultimately falls to the consumer as to whether or not a purchase is made.
Commission Levels
There are more ways to calculate commissions than what we’ve covered so far. One popular method is to offer a variety of levels of commissions, so higher sales will result in a higher commission, and vice versa. This encourages your salespeople to get their sales levels over a predetermined amount in order to get the highest commission rate. This graduated commission scale would work something like this:
The first $10,000 in sales would yield a 5% commission
The next $20,000 in sales would yield a 7% commission
Anything over $30,000 in sales would yield a 10% commission
The gross pay calculation using this commission pay scale would follow this structure: ($10,000 x 0.05) + ($20,000 x 0.07) + ($30,000 x 0.10) = $4,900
Tips
There is also the method of using a base salary plus tips. This is more intended for restaurant settings, where servers typically receive between $2.50 and $5 per hour, not including tips. Any business that pays under minimum wage has to prove that their employees make at least minimum wage after all tips are accounted for. These tips are then reported on the IRS Form 4070, Employee’s Report of Tips to Employer, which is part of the IRS Publication 1244, “Employees Daily Record of tips and Report to Employer.” This document provides the details about what the IRS expects you and your employees to do if they work in an environment where tipping is common and can be found here.
You, as the employer, will have to report your employees’ gross taxable wages based on salary plus tips. This amount is calculated by simply adding the base wage to the tips. So, if your employee is making $2.75 per week, worked a 40 hour week, and made $400 in tips, the equations looks like this:
($2.75 x 40) + $400 = $510
You’ll notice that without the money from tips, your employee only made $110. It falls to you to ensure that your employees are earning at least the minimum wage rate per hour if their tips do not compensate them sufficiently. In the above example, you can take the total amount made ($510) and divide it by the hours worked (40) to see that they make $12.75 per hour for that week. All taxes due are calculated on the base wage plus tips, so the employee will be paid that $510 minus any taxes due.
Taxes
Commissions on sales of goods or insurance premiums are subject to federal income tax withholding and social security, Medicare, and FUTA taxes when paid to an employee. This stands true whether or not the employee was directly involved in selling the product. For full-time life insurance salespeople, special rules are applicable to statutory employees. Commissions paid to them are not subject to federal income tax withholding, but they are subject to social security and Medicare taxes when paid. The commissions are excluded from wages for FUTA tax purposes only if the salesperson is paid by commissions alone with no base pay.
This should give you a good idea about how to calculate the gross pay for your commissioned employees, and how taxes work on these payments. Keep in mind that commission is going to vary depending on the nature of the sales job. Writing commission checks for a car dealership salesperson is going to be different than doing so for someone selling life insurance, which is going to be different than someone selling a vacuum. The one thing that is consistent between these various jobs is that it is vital that you have a payroll software that does the majority of the work for you. Manually calculating your payroll leaves a lot of room for error, and takes up way too much time. If you’re interested in learning about what Dominion can do for your commissioned employees, request a personalized demo!
