Whether your employer pays you a bonus for meeting certain goals or offers a commission for each client you bring in the door or for every sale you make, both types of compensation are taxable. Bonuses and commissions are treated differently from the regular salary you earn and are referred to as "supplemental wages." Although the same rates of tax apply to your salary and supplemental wages, the amount of withholding may be different. Taking the time to understand a bonus vs commission will ensure that you have the appropriate strategies and forms ready when tax season arrives.
Except for special types of bonuses, you can expect to pay regular income tax on bonuses as well as your commissions. However, withholding rates can vary depending on IRS rules and your employer's practices.
Understanding Taxes on Bonuses
With the exception of two specific types, all bonuses earned are combined with your ordinary salary and the total is reported in Box 1 of your W-2 form – which you'll report on the line called "wages, salaries, tips, etc." on your tax return. The two exceptions cover bonuses paid out in property, such as an all-expense-paid vacation or piece of jewelry, rather than cash, if you receive it as a length-of-service award or for attaining certain safety standards at work. If your employer has a "qualified plan" in place – which only your company can tell you – you can receive up to $1,600 of the property's cost tax-free, as of the 2018 tax year. Otherwise, only up to $400 is tax-free.
To qualify for the exclusion, a length-of-service bonus must be made to recognize more than five years of employment. If you've received a similar bonus within the last five tax years, the entire bonus is taxed. The tax exclusion for safety-related bonuses, however, is available as long as you're not a manager or administrator. Regardless of your position, safety-related bonuses are taxable if more than 10 percent of eligible employees are given the same bonus.
Understanding Taxes on Commission Income
Commission income is also included in Box 1 of your W-2 and is reported on your tax return the same way. If your employer pays you a commission in advance, it's taxable in the year you receive it – if you're like most taxpayers and report on the cash basis. This is true even if the commission covers work you do in a later tax year. Taxes on commission income are an unavoidable element of this form of payment.
Other Withholding Amounts
The amount employers withhold from your salary for tax is based on the information you provide on Form W-4 and calculations the Internal Revenue Service requires your employer to use. But for annual supplemental wages totaling $1 million or less, the IRS lets your employer determine how much money to withhold in alternative ways.
When bonuses and commissions are combined with your salary in a single check, or with two or more checks given to you on the same day as your payroll check, your employer can withhold as if all payments are for regular wages. For bonuses and commissions that aren't paid out with your salary, your employer can withhold 25 percent from each check.
Regardless of how your employer decides to withhold taxes, as the amount of your bonus and commissions increases, so does the percentage that's withheld. This represents one similarity rather than a difference between bonus and commission. That being said, remember the amounts withheld are just estimates of what you'll owe the IRS – it doesn't necessarily mean you'll owe that much on your return. Only after the tax year closes and you fill out a tax return with final salary, bonus and commission information will you know whether some of the money withheld will give you a tax refund.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.