Do you pay taxes on commission income? If so, how are commissions taxed in 2020, 2021 or any other year, for that matter?
Well, it depends on what approach you opt for. You can pay taxes on commission income as a self-employed person or opt for taxes for commission for employees. The procedure is different for each option.
Generally, Forms W-4, W-2, 1040, 8919 and 1099-NEC will come into play whenever taxes are concerned. So, it helps to understand what is expected of you to avoid problems with the IRS later on.
File Commission Tax Returns as an Employee
According to the IRS, you are an employee if the work activities you do and how you do them are under the control of an employer. And that is regardless of whether you have a significant amount of freedom while in employment. As an employee working for commission, your employer may give you a percentage for every sale that you generate. Because that payment is compensation for the services you offer, the IRS considers it taxable income.
You must report your commission in the tax year you receive it, even if it is offered in advance. But if you pay some of it back as unearned commission, you can reduce your taxable income in the year you returned it.
Such rules apply to people such as those paid on commission for selling products like life insurance for one company and home-based contractors who must create products and deliver them to a client based on specific orders. They may also include traveling salespeople who provide orders to support the principal activities of a business by selling their products to third parties.
You could be an independent contractor, but the law may statutorily consider you as an employee. So, take note of that.
Understanding Forms W-2, W-4 and 1040
You should receive a Form W-2 copy from your employer. The IRS form shows what you earned in commissions and how much of your money was withheld as taxes. Ideally, you should receive one so long as you make at least $600 in any given tax year after Social Security, Medicare and taxable income have been deducted.
Read More: W-2 Forms: What It Is, Who Gets One & How It Works
Typically, the amount your employer withholds will be based on the information you provided in Form W-4. The form also contains information about any allowances you can claim to reduce the taxes that the employer withholds.
You can find information about the commissions you earned for the current tax year in Form W-2 Box 1, which shows the wages, tips and other compensation. And then, you can use it to file your individual income taxes via Form 1040 or 1040-SR. The commission amounts will go into the section showing the wages you earned, which is line 1 on Form 1040.
File Taxes on Commission as a Self-Employed Person
According to the IRS, you are no longer an employee but self-employed if you are in business for yourself, part of a business partnership or carry on work activities as a sole proprietor or independent contractor. In such cases, you will be in control of your activities and how you carry them out.
When you are self-employed, you are responsible for paying all of your taxes, including Social Security (12.4 percent) and Medicare taxes (2.9 percent). That is double what an employee would pay.
You must file taxes if your net earnings from commissions are $400 or more in any given tax year. And typically, 92.35 percent of that amount will be subject to self-employment taxes.
Understanding Forms 8919, 1099-MISC, W-4 and 1040
If your employer has not withheld your payroll taxes, you must file Form 8919. This IRS form will enable the government to determine how much Social Security and Medicare taxes you owe from your commissions if your employer treated you as an independent contractor rather than an employee.
Form 1099-NEC comes in when you work as an independent contractor for a business or trade client and earn commissions of at least $600 from them in a given tax year. You can find the payment information in box 1 of that form.
Read More: Form 1040: What You Need to Know
Alternatively, if your client is not engaged in trade or business, they may give you Form 1099-MISC. In this Form 1099, for commissions paid, the information will be available in box 7.
When filing your own taxes on Form 1040, you can then use that information to fill in the commission income you earned for the tax year in Schedule 1 of Form 1040 or Schedule C of that same form, depending on your employment status. And your allowable expenses will into Schedule A under Itemized Deductions.
In addition, as a self-employed person, you may need to complete Schedule SE. Also, if you intend to make quarterly estimated taxes, you need to file Form 1040-ES.
Read More: Form 1040: What's Changed for Your 2020 Tax Return
It is essential that you know which commission tax forms to use when filing your own taxes. If you opt for the wrong one, you may end up submitting inaccurate information and owe the IRS. Therefore, determine what your employment status is and how much money you made in commissions first. And then, you can file commission taxes properly.
- Corporate Finance Institute: Commission
- IRS.Gov: Publication 525 (2020), Taxable and Nontaxable Income
- IRS.Gov: Statutory Employees
- IRS.Gov: Self-Employed Individuals Tax Center
- IRS.Gov: 2020 Instructions for Forms 1099-MISC and 1099-NEC
- IRS.Gov: 1099 MISC, Independent Contractors, and Self-Employed 1
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