Calculating Taxes on Sales Commissions
If you'll be receiving a draw on a sales commission, it's very important to understand its pros and cons, how the amount of the draw is calculated, and how taxes are computed.
The primary advantage of a draw against commission is that you, the salesperson, has some regular income and an ongoing incentive to meet sales goals. The disadvantage is that the draw must be paid back if sales commission levels aren't met. On the other hand, the employer may lose the draw if the employee quits.
Your employer will usually have a good idea about your projected income or what you can reasonably expect to earn, based on the territory, sales rep experience and market expectations. The draw is based on a percentage of that figure, and the amount of the percentage varies depending on the industry, the territory, reasonable living expenses and the sales representative's experience.
For example, if your projected commission is $4,000 a month, the company could offer a draw of $500 a week, or $2,000 a month. That means you would be paid $500 a week. At the end of the month, if you met the $4,000 sales goal, you'd be paid an additional $2,000. If sales were $3,000, you would earn an additional $1,000; if sales were $5,000, you'd earn an additional $3,000.
What if your overall commissions fall short of your draw? That depends on the terms of your agreement with your employer. Some companies require repayment of the draw right away, while others allow some additional time or sales cycles to help you establish a territory and make up the draw.
Calculating taxes on sales commissions is relatively simple: The draw and the commission are taxed together as ordinary income. For example, say you earned a $25,000 draw and an additional $50,000 in commission. Total compensation for the year is $75,000, and taxes must be paid at the appropriate income rate.
Some earners may be surprised by their tax bill if they haven't planned for right tax rate all along. For example, if you receive a monthly draw of $2,000, your employer may withhold taxes at the tax rate appropriate for an annual income of $24,000. When you receive a bonus of $50,000 that raises your total income up to another bracket, don't be surprised to discover that you'll be paying Uncle Sam at a higher tax rate.
For more on taxes and other financial obligations, see the links on the next page.