How to Pay Commission-Based Employees: Payroll, Taxes and Overtime

When part of your team earns commission, their pay changes from one paycheck to the next. Commission you pay an employee is wages, so you add it to gross pay, withhold taxes on it and report it with the rest of their pay. If the employee is non-exempt and covered by the Fair Labor Standards Act (FLSA), two more rules apply. Each workweek's pay has to meet the minimum wage. Commission also counts toward the regular rate you use to figure overtime, even when you calculate the commission after the workweek ends.

Payroll software such as SurePayroll® By Paychex lets you add commission to a payroll run alongside regular wages.

How commission is taxed and reported through payroll

Commission you pay an employee is taxable wages, so you process it through payroll with the same withholding and reporting as the rest of their pay. Add it to gross pay in the paycheck you pay it in.

For federal income tax withholding, the IRS treats commissions as supplemental wages, the same category as bonuses, back pay and retroactive pay increases. How you withhold depends on how you pay the commission:

• Paid with regular wages, with no separate amounts: withhold federal income tax as if the total were a single payment for a regular payroll period.
• Paid separately, or listed separately on the same paycheck: if you withheld income tax from the employee's regular wages in the current or prior calendar year, you can withhold a flat 22% on the commission or use the aggregate method. If you didn't, use the aggregate method, which adds the commission to regular wages, figures withholding on the total and subtracts what was already withheld.

The same rules apply to bonuses, and how to pay an employee bonus works through both methods. The bonus tax calculator estimates take-home pay on a supplemental payment.

Federal income tax withholding is one part of the commission paycheck. Whichever method you use, you also withhold the employee's share of Social Security and Medicare taxes on the commission and pay the employer's share, along with federal unemployment (FUTA) tax. Then apply state and local income tax withholding where it's required, using your state's rules for supplemental wages.

At year-end, you include commission with the employee's other wages on Form W-2, Wage and Tax Statement.

Minimum wage and overtime coverage for commission-paid employees

Before you calculate commission pay, determine which minimum wage requirements and overtime rules apply to the employee. Being paid commission doesn't, by itself, determine whether an employee is exempt from minimum wage or overtime requirements. The small business overtime guide explains FLSA coverage, and exempt vs. non-exempt employees explains the exemption tests.

For an employee who's covered by the FLSA and non-exempt, two terms drive the calculations that follow:

• Workweek: a fixed, regularly recurring period of seven consecutive days that you set (29 CFR 778.105). The FLSA checks minimum wage and overtime one workweek at a time.
• Regular rate: the regular rate of pay is the hourly rate you figure overtime on. You build it from the employee's pay for the workweek, including commission.

Some commissioned salespeople fall under a separate exemption: an outside salesperson, whose primary duty is making sales or obtaining orders or contracts for services or for the use of facilities, and who's customarily and regularly engaged away from your place of business, is exempt from both minimum wage and overtime, with no salary requirement (DOL Fact Sheet #17F). A narrower exemption under Section 7(i), for some commissioned employees of retail or service establishments, covers overtime only.

State rules can set a higher bar. When an employee is subject to both state and federal minimum wage rules, they're entitled to the higher of the two, and state overtime rules can also go further than federal rules. Check your state labor department for the rules where your employees work.

How to check minimum wage for commission pay each workweek

For a commission-paid employee who's covered by the FLSA and subject to its overtime requirements, check each workweek: divide the employee's total pay for that week by the hours they worked in it. If the result falls below the minimum wage, you owe the difference, and it's ordinarily due on the regular payday for that workweek (DOL Field Operations Handbook, Chapter 30).

A pay period that covers two workweeks doesn't let you average them, so a strong week can't make up for a slow one. This check matters most for employees paid by commission alone or with a low base. For the minimum wage check, an hourly rate at or above the applicable minimum wage already covers each hour worked.

Here's how it works for an employee paid only commission on a biweekly schedule, at the $7.25 federal minimum wage:

The employee averaged $10.00 an hour across the pay period, but week 2 fell short. You add $90 to that paycheck, for a total of $890. Where your state or locality sets a minimum wage above $7.25, use the higher rate.

How commission affects the regular rate and overtime pay

For a non-exempt employee, commission earned in a workweek is part of that week's regular rate, whether commission is their only pay or comes on top of an hourly rate or salary (29 CFR 778.117). When you pay commission weekly, add it to the employee's other earnings for the week, divide by total hours worked, and pay an extra half of that rate for each overtime hour (29 CFR 778.118).

How you build the regular rate depends on the pay structure:

Here's the hourly-plus-commission row with numbers. Your employee earns $15 an hour, works 45 hours and earns $180 in commission that week:

1. Straight-time pay: $15 × 45 hours = $675, plus $180 commission = $855.
2. Regular rate: $855 ÷ 45 hours = $19.00.
3. Overtime premium: half the regular rate, $9.50, × 5 overtime hours = $47.50.

The week's total pay is $902.50. Paying overtime on the hourly rate alone, at $22.50 for each overtime hour, comes to $892.50, which is $10 short. The small business overtime guide applies the same regular-rate method to non-discretionary bonuses.

How to calculate overtime when commission is paid after the workweek

When you can't calculate a commission by the regular payday, you can pay overtime without it at first. Once you calculate the commission, you owe additional overtime for each workweek it covers that had overtime hours (29 CFR 778.119).

Work through it in three steps:

1. On each regular payday, pay overtime at no less than 1.5 times the regular rate without the commission.
2. When you calculate the commission, apportion it back over the workweeks it was earned in.
3. For each workweek with overtime, divide that week's share of the commission by the hours worked that week to get the increase in the hourly rate. Pay half of that increase for each overtime hour.

Sometimes you can't tie a commission to the weeks it was earned. In that case, 29 CFR 778.120 calls for another reasonable and equitable method and describes two:

• Equal amounts per week: treat the commission as earned evenly across the period. Divide a commission for a set number of weeks by the number of weeks. For a monthly commission, multiply by 12 and divide by 52.
• Equal amounts per hour: when weekly hours vary significantly, divide the commission by the total hours worked in the period, then pay half that amount for each overtime hour.

In this example, you pay $15 an hour and figure commission every four weeks on total sales, which can't be traced to specific weeks. The $1,100 commission is paid after the period ends. Hours were steady, so equal amounts per week fit:

Week 2's paycheck already paid four overtime hours at $22.50. With the commission, you add $12.50: half the $6.25 rate increase for each of those four hours. The commission itself is taxed as supplemental wages in the paycheck you pay it in.

The retail or service establishment overtime exemption for commissioned employees

Section 7(i) of the FLSA exempts some commissioned employees of retail or service establishments from overtime, not from minimum wage, and only when all three conditions are met (DOL Fact Sheet #20):

• The employee works for a retail or service establishment.
• Their regular rate is more than 1.5 times the applicable minimum wage for every hour worked in a workweek with overtime.
• More than half of their total earnings over a representative period, at least one month and no more than one year, are commissions.

If all three conditions aren't met, Section 7(i) doesn't provide the overtime exemption. Fact Sheet #20 explains how the Department of Labor (DOL) applies each condition.

Commission pay records and written commission terms

Keep payroll records that let you reconstruct each employee's commission basis, hours, regular rate and overtime by workweek. Under 29 CFR 516.2, the FLSA payroll records you keep for each non-exempt employee include:

• the day and time each workweek begins
• the basis of pay, such as commission on sales
• the regular hourly rate for any workweek with overtime
• hours worked each workday and each workweek
• straight-time earnings and overtime premium pay
• the date of payment and the pay period it covers

Separately, 29 CFR 516.6 requires you to preserve the customer orders and invoices you keep in the usual course of business for at least two years. That rule applies to those business records generally, not only to records used for commission. The small business overtime guide covers how long to keep each type of payroll record.

Some states require a written commission agreement. California, for example, requires a written contract for employees working in the state that sets out how commissions are computed and paid, with a signed copy for the employee and a signed receipt from them (Cal. Labor Code §2751). Check your state labor department for the rules that apply to you.

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Add commission to payroll with SurePayroll

You set each employee's commission rate, decide how commission is earned and determine each amount.

In SurePayroll, you add commission to a payroll run as an additional pay type alongside regular wages. SurePayroll calculates payroll and payroll taxes, pays your employees and makes applicable payroll tax deposits and filings.

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