A sales commission is variable pay tied directly to what a salesperson sells: rather than earning a flat paycheck regardless of output, a commissioned worker takes home more when they close more deals. The company gets revenue, and the salesperson gets a cut of it. Federal law treats commissions paid to employees as supplemental wages, which means they follow specific withholding rules and interact with overtime law in ways that catch many workers off guard.
How the Commission Amount Is Calculated
Every plan starts with a calculation basis, the number the commission percentage applies to. Three approaches dominate.
- Gross revenue. The commission is a percentage of the total dollar amount sold, before costs. A $50,000 deal at 10% pays $5,000 whether or not the company profited on the sale. Simple to track, but it rewards volume without regard to profitability.
- Net profit. The commission is a percentage of what is left after subtracting cost of goods sold and other direct expenses. If that same $50,000 deal cost $35,000 to fulfill, the commissionable amount is $15,000, and a 20% rate pays $3,000.
- Margin. Similar to net profit but usually calculated as the spread between selling price and the cost basis of the specific product or service. Every additional dollar of margin flows straight into the commission.
Gross revenue plans push volume. Profit and margin plans push deal quality. Many companies blend the two or shift between them as priorities change.
Common Commission Structures
The calculation basis tells you what number gets multiplied. The compensation structure tells you how the pay package fits together.
- Straight commission. One hundred percent variable pay, no base salary. Top performers can earn well; a bad month means a near-empty paycheck. Most common where individual deals are large and cycles short enough to produce regular income.
- Salary plus commission. A fixed base provides stability, and a commission component (usually at a lower rate than a straight-commission plan) rewards performance on top. The most widely used structure because it balances risk while keeping the incentive alive.
- Tiered or accelerated commission. The rate rises as the salesperson crosses set thresholds. A plan might pay 5% on the first $100,000 in quarterly sales and jump to 8% above that. The acceleration pulls people past quota rather than letting them coast.
- Residual commission. Ongoing payments for as long as the customer account generates revenue. Insurance agents and software salespeople frequently earn residuals on renewals and subscriptions. The model rewards building a durable book of business.
Draws Against Future Commissions
A draw is an advance against commissions the salesperson is expected to earn later. It exists because commission income is lumpy, especially for new hires who may go weeks before closing a first deal. The form of the draw matters enormously.
- Recoverable draw. The employer advances a set amount each pay period and uses future commissions to pay it back. Take a $3,000 monthly draw, earn $5,000 in commissions that month, and you receive the $2,000 difference. Earn only $1,500, and you owe $1,500 that carries forward as a negative balance. The debt accumulates until commissions catch up.
- Non-recoverable draw. A guaranteed minimum payment that never has to be repaid. If commissions fall short, the salesperson keeps the draw. If they exceed it, the salesperson receives the full commission amount. A floor beneath income.
The difference should be spelled out in writing before the salesperson starts work. A recoverable draw that runs for several months on low sales can leave a worker owing thousands, a situation that shocks people who assumed the draw was a guaranteed salary.
What the Commission Agreement Should Cover
When a pay dispute arises, both sides point to the written agreement, and vague language almost always hurts the salesperson more than the employer. At minimum, the agreement should state the commission rate and calculation basis, the sales events that trigger a commission, the payment schedule, and what happens when a deal falls apart after the commission has already been paid.
Clawback Provisions
Most commission agreements include a clawback clause letting the employer recover commissions when a customer cancels, defaults, or returns a product within a defined window. Clawbacks are standard in industries with long contract terms or trial periods. A $2,000 commission on a 12-month contract may be partly or fully refundable if the customer cancels in month three.
Enforceability varies by state, so the agreement needs to define the clawback window, the method of recovery (deduction from future commissions or direct repayment), and whether it applies to the full commission or only a prorated portion. Ambiguous clawback language is one of the most common sources of commission disputes.
Post-Termination Commissions
What happens to pending commissions when a salesperson leaves the company is another frequent conflict. Some agreements pay only on deals that fully close before the last day of employment. Others pay on pipeline deals that close within a defined period after departure. Many states have specific statutes governing when earned commissions must be paid after termination, with timelines ranging from the final day of employment to the next regular payday. The agreement should address this directly.
Overtime and Minimum Wage Rules for Commissioned Workers
Federal wage law does not exempt commissioned salespeople from overtime or minimum wage protections by default. Whether an exemption applies depends on the type of sales work and the pay structure.
Retail and Service Establishment Exemption
A retail or service employer is not required to pay overtime to a commissioned employee if two conditions are met: the employee’s regular rate of pay exceeds one and one-half times the federal minimum wage, and more than half of the employee’s total earnings over a representative period of at least one month come from commissions.1Office of the Law Revision Counsel. 29 U.S. Code 207 – Maximum Hours Employers using a draw-plus-commission structure can count commissions toward the 50% threshold even when the draw exceeds the commission in a given period.2U.S. Department of Labor. Fact Sheet #20: Employees Paid Commissions By Retail Establishments Who Are Exempt Under Section 7(i) From Overtime Under the FLSA
If either condition fails, the employee is entitled to overtime at one and one-half times their regular rate for hours beyond 40 in a workweek. Employers get tripped up when a slow stretch drops a worker’s effective hourly rate below the threshold.
Outside Sales Exemption
Salespeople who work primarily in the field qualify for a broader exemption. An outside sales employee is exempt from both overtime and minimum wage requirements if their primary duty is making sales and they customarily work away from the employer’s place of business.3Office of the Law Revision Counsel. 29 U.S. Code 213 – Exemptions Unlike most white-collar exemptions, there is no minimum salary requirement.4U.S. Department of Labor. Fact Sheet #17F: Exemption for Outside Sales Employees Under the Fair Labor Standards Act (FLSA)
Where the work happens is the key. A salesperson who makes calls from a home office or company headquarters and closes deals by phone or email is not an outside salesperson, even if they occasionally visit clients. The exemption requires that working away from the employer’s premises is the norm, not the exception.4U.S. Department of Labor. Fact Sheet #17F: Exemption for Outside Sales Employees Under the Fair Labor Standards Act (FLSA)
Minimum Wage as a Floor
Regardless of structure, an employer must ensure that total compensation for each pay period equals at least the federal minimum wage for every hour worked. If commissions and any base pay combined fall short, the employer must make up the difference. This applies to straight commission, salary-plus, and draw arrangements alike. Some states set minimum wages above the federal level, which raises the floor further.
Employee or Independent Contractor?
Not everyone earning commissions is an employee. Independent sales agents, brokers, and freelance reps also earn commission-based pay, and the tax and legal treatment differs completely. The IRS uses a control test: if the company controls not just what the salesperson accomplishes but how they accomplish it, the worker is an employee; if the company controls only the result and the salesperson decides their own methods, schedule, and approach, the worker is an independent contractor.5Internal Revenue Service. Independent Contractor Defined
Employers report an employee’s commissions on a W-2 and withhold income tax, Social Security, and Medicare from each payment. Independent contractors receive a 1099-NEC and handle their own tax payments, including self-employment tax that covers both the employer and employee portions of Social Security and Medicare.5Internal Revenue Service. Independent Contractor Defined Contractors are also not covered by FLSA minimum wage and overtime rules. Misclassification creates liability for the company and unexpected tax bills for the worker.
How Commissions Are Taxed and Withheld
The IRS classifies commissions paid to employees as supplemental wages, a category that also includes bonuses, overtime, and back pay.6eCFR. 26 CFR 31.3402(g)-1 – Supplemental Wage Payments They are subject to federal income tax withholding, Social Security tax, and Medicare tax, but the method for calculating income tax withholding differs from regular wages.
Federal Income Tax Withholding
When commissions are paid separately from regular wages, or paid together with the amount of each specified, the employer can choose between two methods.7Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
- Flat rate method. The employer withholds a flat 22% from the commission for federal income tax. No other percentage is allowed. Most payroll departments prefer this for large or irregular commission checks because the calculation is simple.
- Aggregate method. The employer adds the commission to the regular wages paid in the same period, calculates withholding on the combined total as though it were a single regular payment, then subtracts the tax already withheld from regular wages. The remainder is withheld from the commission. This can produce higher withholding if the combined amount pushes the calculation into a higher bracket for that period.
If an employee receives more than $1 million in supplemental wages during a calendar year, the excess over $1 million is subject to a mandatory 37% withholding rate regardless of the method chosen or what the employee’s W-4 says.7Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
Social Security and Medicare
Commission pay is subject to Social Security tax at 6.2% on earnings up to $184,500 in 2026.8Social Security Administration. Contribution and Benefit Base Once combined regular and supplemental wages for the year cross that threshold, no further Social Security tax is withheld. Medicare tax of 1.45% applies to all earnings with no cap.9Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
High earners face an additional layer. Employers must withhold an extra 0.9% Additional Medicare Tax on wages exceeding $200,000 in a calendar year.10Internal Revenue Service. Questions and Answers for the Additional Medicare Tax The $200,000 employer-withholding threshold applies regardless of filing status, though the actual liability threshold is $250,000 for married couples filing jointly. A commissioned salesperson whose base salary and commissions together push past $200,000 will see the extra withholding start on remaining paychecks for the year.