If you work on commission, you face a number of financial and tax-related challenges. One key to making it work successfully is to understand how being a commission worker affects your taxes and how you can lower those taxes. Here is a handy tax guide for anyone entering the world of commissions.
Independent Contractor vs. Employee
The first thing to understand when taking commission-based work is whether you will be an employee or an independent contractor. This is because income taxes are handled differently — as are things like unemployment compensation, pay schedules, and workers' compensation. For tax purposes, be aware that working as an independent contractor means you will be paying regular income tax on your commission as well as a 15.3% self-employment tax (basically, your Social Security and Medicare obligations). It also may mean sending in quarterly tax payments since no one is deducting from your check.
Getting a regular hourly or salary paycheck on a consistent basis means that the calculations for payroll taxes and income taxes will be largely similar. However, when you only receive commission checks once a quarter or annually, those are likely to be taxed at a higher rate because the larger individual check fell into a higher taxation rate based on its size. This doesn't necessarily mean you will end up paying more when you file your return in the spring, but it can mean a smaller net amount than you expected. You may be able to fight this problem by lowering your withholding amount before a large commission check arrives. Just be sure to readjust the withholding afterward and not to underestimate your tax burden. Working with a professional in tax services can help you calculate this.
Lowering Your Taxes
Depending on how you earned the commission, there may be ways to reduce its impact on your taxes. One way is to ask to be put on the company's payroll. As mentioned above, this would reduce the amount of payroll taxes you pay by shifting half of the self-employment tax obligation onto the employer. But, regardless of whether you're an employee or a subcontractor, you can still reduce taxable income by claiming deductible expenses. Deductible (business or employee) unreimbursed expenses include things like travel, car expenses or mileage, meals with clients, marketing materials, fees related to your work, association dues and costs to run your own home office. Health insurance may be deductible if you have not already received a tax benefit from it.
By knowing how your taxes will change by becoming a commission worker — and how you can combat it — you can make the best decision about your employment and keep the most amount of your earnings in your pocket. For more information, contact local professionals like Balkcom Pearsall & Parrish CPA's PA.