Bonuses and commission are two types of pay used to motivate and reward employees. Although they’re both considered forms of compensation and are separate from base pay, they have important differences.
These pay structures are often used in sales jobs. Bonuses and commission can incentivize teams to sell more services or products by ensuring that top sellers earn more than lower-performing peers.
But figuring out pay can become challenging for both employers and their staffs when differing pay structures introduce complexities. Here’s a simplified guide to help you understand the difference between bonus and commission pay.
Understanding bonuses and commission
What is the difference between bonus and commission pay? First, let’s consider how they’re similar. Both are types of variable pay, or compensation that’s determined by sales performance and is given in addition to fixed, or base, pay. With that in mind, here’s a closer look at how the two differ.
A bonus is a sum of money that a company pays its employees at a specific time. In some organizations, employee bonuses are paid to all or a majority of workers during the holiday season. Sales bonuses are different, however. These awards are distributed to sales staff as a fixed amount of money for reaching a specific goal. They can be given to individual employees for reaching personal goals, or to an entire department upon meeting a company-wide goal.
There are several bonus structures companies may use, including:
- A percentage of a salary: In this approach, the employer adds a certain percentage of the employee’s base salary to their pay for meeting a certain goal. For instance, they might earn 4% of their base pay as a bonus.
- Bonus off commission: This sales bonus is paid based on the amount of revenue an employee generates. For example, they might earn $10,000 for a $100,000 deal. They could also earn a bonus for a number of units sold. The bonus amount is typically a percentage of a specific revenue milestone.
- Customer lifetime retention bonus: For companies looking to reduce churn, this bonus can be used to encourage sales teams to focus on customer retention. For example, employers might pay a specific amount for every customer who renews their contract.
- Annual performance bonus: Awarded to employees who go above and beyond for an organization, this type of bonus might be given when someone far exceeds their quota.
- Bonus for a specific product or service: When there’s a certain item or service companies are looking to promote, offering a sales bonus for employees who sell it can be a great motivator. An employer might offer a reward for each time they sell a new product, for example. These incentives are typically only given for short periods of time.
In general, bonuses are easily tied to goals and are ideal for mature companies with an established brand presence. Commissions, on the other hand, can be strong motivators to help start-ups move through growth phases. Let’s take a closer look at what they entail.
Commission can be slightly more complex than bonuses, as they’re determined by a specific rate that may vary based on several factors. Employers often determine commission rates based on certain accomplishments achieved during a set time period. For example, a car sales associate might earn a certain commission for selling 24 cars in one month.
Like bonuses, there are several different approaches employers can
take for commission, including:
- Straight commission: Employers pay this type of commission according to the number of sales an associate generates, based on a pre-determined pay rate they set.
- Variable commission: This type of commission depends on the income that an employer deducts directly from the sales earned. For example, employees might receive a certain percentage of revenue for each sale made, which can vary from one item or service to the next.
- Salary plus commission: With this type of commission, employees receive a base salary in addition to a specific commission based on how many sales they generate.
Are bonuses and commission taxed the same?
Even the most straightforward bonus and commission structures can add complexity to a company’s payroll processes. Additionally, taxes for these forms of variable pay are calculated at a different rate than other income. For this reason, it’s critical for employers who offer variable pay to stay up-to-date with tax regulations to remain in compliance.
In general, bonuses and commissions are taxed the same way. The IRS classifies bonuses and commissions as supplemental wages and levies a flat 22% federal withholding rate for this pay. Just as organizations hold back a portion of their employees’ paycheck to prepay taxes, the same must be done for bonus checks and commissions.
Employers can either use the percentage method or the aggregate method to calculate taxes for bonuses and commission. In the percentage method, a flat 22% (or 37% for values exceeding $1 million) is deducted from the bonus or commissions. In the aggregate method, the commission or bonus is added to the regular wages. Then, the employer calculates taxes using regular income tax rates.
If your business is looking to simplify payroll and tax compliance for commission, bonuses, and overall compensation, allow us to help. Try Oyster’s global payroll tool to see how we can make global payments and compliance hassle-free.
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