How To Pay Commission on Sales in 6 Steps
This article is part of a larger series on How to Do Payroll.
Sales commission is pay an employee receives for selling a product or service your company offers. To pay sales commission, you’ll need to create your sales commission plan, determine which employees are eligible, calculate their commissions, and determine how you’ll pay them, all while ensuring compliance with employment laws.
Using payroll software like Gusto can make it easy; it calculates commission payments and gives you multiple ways to pay them, including direct deposit. Sign up for a 30-day free trial.
Step 1: Create Your Commission Plan
It’s easy to get into the weeds when creating a commission plan. Here’s our best advice at this stage: Don’t overcomplicate it.
A complex commission plan may initially seem more cost-effective for your business, allowing you to pay only on true profits. However, remember that you’ll need to decipher the complexities with each payroll run—which is why keeping it simple will make your life easier.
When deciding on your commission structure, the products or services you sell will partially dictate how you pay commission. For instance, if you’re selling something with a high value, like cars or houses, then you may pay a percentage of the sale or net sale (which is the sale price minus related expenses, i.e., brokerage fees). Meanwhile, staffing agencies often use a tiered commission structure to reward longer-term goals, increasing the commission as workers move up tiers.
You can also take a blended approach, paying a percentage of each sale while also offering tiered bonuses for hitting certain goals. This will make your plan a bit more complex, but it often adds substantial incentive to salespeople.
Follow our guide on sales commission structure to help you decide what works best for your business. Remember to consider your budget and structure your plan so that commissions are only awarded when your company receives payment from customers. It’s also a good idea to include a clause that employees must be in good standing to receive commission payouts.
Step 2: Determine Employees Eligible for Commission
Regardless of your commission structure, you can choose which employees are eligible to receive commissions. Let’s discuss a retail store example.
You have six regular employees who stock shelves, keep the store clean, and generally help customers. You also have two managers who oversee the team of six, handle payment transactions, and ordering. There’s also one payroll specialist on your team who manages time sheets, payroll, taxes, and deductions.
Your small business wants to incentivize employees to make a sale, pushing the products you sell as customers enter the store. To achieve this goal, you’ve created a flat rate commission structure, paying each employee who makes a sale $5.00 in commission for each item they sell.
Your payroll specialist doesn’t interact with customers, so they’ll be ineligible. Your managers may interact with customers, but they’re probably not actively and regularly working to sell your products. But your six regular employees? They’re the eligible employees under your commission plan.
Commission Plan Tip: Make sure your offer letters state whether an employee is eligible for commissions and, if so, lay out the details of that plan.
Step 3: Determine the Type of Commission Paid
Once you’ve determined which employees are eligible for commissions, you need to figure out how to pay them. There are three ways to do this:
- Base Pay + Commission
- Straight Commission
The best and simplest option for small businesses is to pay a base wage plus commission. Depending on your industry, this may mean paying minimum wage for base pay and then commissions on top. This doesn’t require extra calculations, such as with a draw, making for a simplified payroll process.
Some types of workers, like realtors, may work on straight commission. This means they don’t receive any compensation for their work except commission payments when they sell something. Straight commission employees are usually independent contractors. Make sure you understand the differences between independent contractors and W-2 employees so you classify your workers correctly and avoid compliance issues.
Another option to pay your employees a commission is on a draw. Under this plan, you’ll pay employees a base wage, but before they earn commissions, they’ll need to pay back that base wage, called a draw. This is especially helpful for new employees who may not make regular sales yet. A draw gives them wages they can count on until they get up and running.
For example, if you pay your employees $10.00 per hour and a flat $5.00 commission per item sold, they’ll need to sell two items per hour to pay back their base pay. Anything beyond that is a straight commission for them. Draws are usually only used in high-commission environments, like some recruiting companies, where workers can make thousands of dollars per month in commissions.
Keep in mind, regardless of the type of commission plan, you still have to ensure employees are paid at least minimum wage and accurate overtime, if applicable.
Step 4: Calculate Commissions
Part of doing payroll includes paying employees for their earned commissions. You’ll need to calculate these commissions each time you pay out commissions to employees. You don’t have to pay commissions with each payroll, however. You can if you want, but most companies choose to pay commissions just once per month, either with the next payroll run or as a separate commission pay run. Make sure you check your state laws to ensure compliance with pay frequency—more on that below.
Step 5: Calculate Payroll Taxes on Commission Payments
You’re not done after simply calculating commissions—Uncle Sam wants his cut. Figuring out how much tax to withhold depends on when you pay commissions.
If you pay commissions with a regular payroll run, you withhold taxes at the employee’s regular tax rate. If you pay commissions outside of a regular payroll run, you have two options for tax withholding:
- You can withhold taxes at a flat rate of 22%
- You can add the employee’s base pay and commissions, classifying the total amount as regular wages for tax purposes and withhold at the appropriate rate
The flat-rate withholding is simpler, but the second method may result in more accurate tax withholdings, leaving the employee with less tax owed or due at the end of the year. Ultimately, it’s a good idea to discuss these options with your employees and figure out what they prefer.
Step 6: Pay Commissioned Employees
Just like with regular payroll, you have options for how to pay your employees:
- Direct deposit
- Pay card
- Paper check
No matter how you choose to pay them, calculating commissions and taxes adds a layer of complexity to your payroll.
To help you better manage your commissions and ensure compliance with minimum wage and overtime laws, consider using payroll software that does commissions for you. Gusto provides your small business with support and guidance to make sure your commissioned employees get paid correctly and on time.
Laws Affecting Commission Pay
While there are many laws and regulations you need to be aware of as a small business, there are two big ones we need to highlight. Pay attention to these, as companies often run afoul of these issues, leading to costly legal headaches.
Minimum Wage & Overtime
Most salespeople are required to be paid at least minimum wage of $7.25 per hour, unless they meet the exemption of a salesperson who conducts most of their sales outside the office (which applies to both minimum wage and overtime).
You should have employees track their hours so you can verify at the end of the pay period if the employee was actually paid at least minimum wage. If you find an employee hasn’t been paid at least $7.25 per hour, you’ll need to make up the difference. Let’s look at an example.
You have an employee who worked 38 hours and made sales for the week totaling $200 in commissions. You don’t pay them a base wage so the hourly rate for their workweek was only $5.26 ($200 / 38 = $5.26). So your company needs to make up the difference ($7.25 – $5.26 = $1.99). You’ll need to pay your employee an additional $1.99 per hour to meet the minimum wage requirements for a total additional pay of $75.62. That would make their paycheck for this week $275.62.
Your employees making a commission must also earn at least one and a half times the minimum hourly wage for any hours worked over 40 in a single workweek. Taking the current federal minimum wage of $7.25 per hour, your commissioned employees must make at least $10.88 per overtime hour. This amount will include commissions earned. If a commissioned employee does not meet this minimum per week, your company must make up the difference and pay applicable overtime.
As mentioned earlier, there is an exemption for outside salespeople under the Fair Labor Standards Act (FLSA). This means you don’t have to pay an overtime wage if your employees meet the exemption.
To meet this exemption, your small business must be a retail or service-based company which makes at least 75% of its income from sales activities. The outside sales exemption also requires that the sales work occur outside of the place of business—at the customer’s office, for example.
Some states require you to pay employees on certain timelines. Your pay periods must be regular and consistent. In other words, you cannot pay employees monthly this month and weekly next month. Workers are entitled to know when they should expect their paycheck.
The FLSA requires that employers pay commissions at least annually. Most pay monthly. Yet some states are more restrictive. California, for example, requires commissions be paid at least twice monthly, once earned. That’s because the California law considers commissions to be regular wages once the commission is earned and payroll must occur at least twice per month in California.
Tips for Paying Sales Commissions
- Keep it simple. We cannot emphasize this enough. Especially as a small business, your commission plan should not be complex. Make it simple for you, your team, and your accountant.
- Don’t cap earnings. Many companies put a cap on the amount of commissions an employee can earn. Don’t do this. It negates the incentive that commissions provide. The potential to earn more keeps your employees motivated to keep selling.
- Hire right. Be clear in your job description about what you need an employee to do, including sales. Using a structured interview process will help you evaluate candidates effectively and fairly.
- Don’t have unreachable goals. If you set goals for your salespeople, make them reasonable. Lofty goals and stretch goals have a purpose; however, setting goals that are unattainable only serves to negate the incentive a commission plan provides.
Paying commissions is a great way to motivate your employees to make more sales. This helps them by paying them a small commission on everything they sell and helps your company make more money. By understanding how commission pay works, you’ll have an easier time managing all the compliance laws regarding your commission payroll.