The flat rate formula
A flat commission multiplies sales by a fixed percentage. With a 5% rate and $50,000 in sales, the commission is $2,500. Divide the commission by sales to see the effective rate, which here is 5%.
Many plans add a base salary or a draw. A base is paid regardless of sales and commission is paid on top. A draw is an advance against future commission, and any shortfall may need to be repaid or carried forward, depending on the plan.
Tiered and threshold plans
A tiered plan pays a higher rate once sales pass a threshold. Say the rate is 5% up to $30,000 and 8% above. On $50,000 of sales, the first $30,000 earns $1,500 and the remaining $20,000 earns $1,600, for $3,100 in total, an effective rate of 6.2%.
Notice that the higher rate applies only to the sales above the threshold. Mixing this up is a common error and can lead to overpaying or underpaying.
Define the sale clearly
Write down what counts as a sale. Is it the date the order is placed, the invoice is sent or the customer pays? Are returns and discounts subtracted? Are taxes and shipping included? Plans that leave these open produce disputes.
Many businesses pay commission only after the customer has paid, which protects against bad debts. Whatever you choose, state it in the written plan and apply it the same way every time.
Recording commissions in your books
Commission is a payroll cost for employees and is usually reported as wages, with the usual withholding. For independent contractors it is a payment for services and may need to be reported differently. Ask a payroll provider or tax preparer how it applies to your situation.
Accrue commissions that have been earned but not yet paid, so your expenses match the sales they relate to. If commission is paid after collection, record the liability when the condition is met.
Test the plan before you launch
Run the plan against a few past months of real sales to see what you would have paid. Check that the total is affordable, that the top performer is not paid more than the business can sustain and that the structure rewards the behavior you want.
A calculator can speed this up, but the plan itself should be written, signed or acknowledged, and reviewed once a year. Margins matter too, since a commission on a low-margin sale can eat the whole profit.
A plan checklist
Before you roll out a plan, write answers to a few questions. What exactly counts as a sale? Which products or customers are included? Are returns subtracted and over what period? When is commission earned and when is it paid? Is there a cap, a floor or a draw?
Also decide what happens when someone leaves or when an account is lost after payment. Plans that answer these in writing avoid awkward conversations later, and they make your bookkeeping simpler because every payment follows a rule.
Common questions
Is commission paid on gross or net sales?
It depends on the plan. Many use net sales after returns and discounts. Write it down so there is no doubt.
What is a draw?
An advance on future commission. The plan should say whether the draw is repaid if commissions fall short.
Do I have to withhold taxes on commission?
For employees, yes, commission is generally treated as wages. Check with your payroll provider or a tax preparer.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.