How Commission Works and How to Choose the Right Payroll StructureJordan Nottrodt
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Within a commission structure, a company compensates its employees based on the revenue they generate for the business.
By definition, commission is a fee paid to an employee for transacting a piece of business or performing a service.
Commission structures are most common in sales heavy industries, such as retail, real estate, insurance and the stock market. Theres also a prominent spot for commission structures within sales teams of direct sale products or services. Direct sale products or services are sold directly to a customer, without having a retail storefront.
There are different tax treatments for commissions, versus other income types.
If you are running your own payroll, make sure you are aware of the commission tax guidelines for your country, state/province or city. If you run payroll using online software, you should make sure they are able to calculate taxes on commission pay.
At Wagepoint, we calculate all of the applicable taxes on provided gross commission totals. As an employer, you need to provide the gross commission amount and we take care of the rest, including all year-end reporting.
Gross Commission Calculation
Sales - $40,000
40,000 x 5% (0.05) = $2000
Your employees gross commission total would be $2000.
Employers need to calculate a gross commission value for each employee depending on the different employment commission structures.
In this post, we will outline 7 different ways you can include commission in your pay structure.
- Bonus Commission
- Commission Only
- Salary + Commission
- Variable Commission
- Graduated Commission
- Residual Commission
- Draw Against Commission
1. Bonus Commission
Bonus commissions are an opportunity to reward employees for their success. These bonuses are in addition to an employees established pay and are usually based on pre-established earning quotas.
Bonus commissions can be awarded to individuals, teams or even company-wide for extraordinary performances.
If the bonus commission was 5% of a huge $10,000 sale, the employee would receive a $500 bonus, minus all applicable taxes, in addition to their regular pay.
(10,000 x 0.05 = 500)
This type of sales commission structure is common within startup organizations that want to reward high achievers and keep up office morale.
Remember that any bonuses paid to an employee, even as a cash gift, are considered taxable and should be included within their total yearly earnings.
Learn more about How to Handle Taxes on Bonus Wages in the US and Canada.
2. Straight Commission
Straight commission can also be referred to as commission-only because it is the only pay an employee receives. There is no base salary or hourly wage included in this pay structure.
All compensation is based on an agreed-upon percentage of sales. Companies can benefit from a straight commission setup because they do not have to pay for anything unless an employee is generating business.
If an employee brings in $50,000 of business in a month and their commission rate is 8%, they would be paid $4000, minus all applicable taxes.
(50,000 x 0.08 = 4000)
This type of commission is most common within the real estate and auto industries.
3. Salary + Commission
A salary with commission is the most common type of commission structure. In this case, an employee has a fixed salary base, but they also receive commissions for their sales or performance.
This structure has the luxury of stability while also encouraging employee performance. The fixed salary is steady, but generally smaller because much of someones income is still determined by sales.
If an employee brings in $50,000 of business in a month and their commission rate is 4%, they would be paid $2000, plus their salary, minus all applicable taxes.
(50,000 x 0.04 = 2000)
This type of commission is most common within retail industries.
4. Variable Commission
Variable commission is as it sounds, varying based on the type of sale.
With this setup, any simple or easy to acquire sales can be rewarded differently than tough sales to encourage growth in specific markets. It can also be used to reward the sale of long-term contracts or highly desirable customers.
If an employee brings in $40,000 of regular business at a commission rate of 5% as well as $10,000 of highly desirable business at a commission rate of 15%, they would be paid $3500, minus all applicable taxes.
(40,000 x 0.05 = 2000 + 10,000 x 0.15 = 1500)
(2000 + 1500 = 3500)
This type of commission is most common for businesses trying to break into new markets because the setup encourages and rewards specific types of sales.
5. Graduated Commission
A graduated commission focuses on performance. A company can set up various tiers, and an employee will be paid the commission amount for the achieved level of sales.
This could look like 5% of the first $20,000 of sales, 10% of the next $20,000 of sales and 15% of any sales made above the $40,000 mark.
The actual commission percentage will increase incrementally at a predetermined rate as an employee reaches higher levels of sales.
If an employee brings in $50,000 of business in a month and their commission rate is 5% on the first $20,000 and 8% on anything above that amount, they would be paid $3400, minus all applicable taxes.
(20,000 x 0.05 = 1000 + 30,000 x 0.08 = 2400)
(1000 + 2400 = 3400)
This type of commission is most common for businesses that want to incentivize sales volume.
6. Residual Commission
A residual commission structure is for ongoing accounts. With this setup, an employee will continue to receive commission on a sale as long as it continues to generate revenue.
Residual commission has both pros and cons for sales employees.
Employees can benefit from this type of commission because, after a time, they will begin to build a steady commission income from their residual sales. On the flipside, losing a long-term sale can suddenly reduce an employees earnings by a significant amount.
If an employee brings in $50,000 of monthly business and their commission rate is a residual 5%, they would be paid $1000, minus all applicable taxes. This $1000 pay would continue every month so long as the sale continued to bring in $50,000 of revenue each month.
(50,000 x 0.05 = 1000)
This type of commission is most common for agencies, consulting firms and any businesses that prioritize long-term accounts.
7. Draw Against Commission
With a draw against system, employees are advanced a predetermined draw thats deducted from their commission on each following pay.
After the draw amount is paid out of the commissions on the following pay, the employee is left with the remainder. If an employee is unable to make the draw amount in commissions, they will owe that amount back to the company.
Someone can take additional pay from the next set of commissions, but if an employee has a few bad sale cycles in a row, they can be left with significant debt.
If an employee brings in $50,000 of business in a month and their commission rate is 8%, they would be paid $4000. The draw amount that they received in advance (Ex. $3000) would be subtracted from the gross commission total, leaving an extra $1000, minus all applicable taxes.
(50,000 x 0.08 = 4000)
(4000 - 3000[draw] = 1000)
This type of commission is most common for businesses with lengthy or seasonal sales cycles.
The different types of commission setups can be combined to create the perfect structure for your business. A salary + commission structure can be specialized by also including a graduated or variable system.
Its all about finding what works best for your business.
If you are implementing a new commission structure or you are changing an existing one, we recommend that you visit the United States Department of Labor Commissions page. For Canadian companies, you should visit the Canada Revenue Agencys page on employees paid by commission.
Disclaimer: The advice we share on our blog is intended to be informational. It does not replace the expertise of accredited business professionals.
About the Author
Jordan comes from a background of agency communications and strategic problem solving. She is passionate about inbound marketing and believes that the best content comes from knowing your audience and giving them exactly what they want. Working remotely for Wagepoint, she has been able to pursue her other passion of travelling the world one city at a time. Spark an immediate and detailed conversation with Jordan by mentioning Mad Men or Game of Thrones.