How to Determine Payroll for Employees Receiving Commission Checks

By Lita Epstein

Running payroll for employees paid based on commission can involve the most complex calculations. To show you a number of variables, this example shows you how to calculate a commission check based on a salesperson who sells $60,000 worth of products during one month.

For a salesperson on a straight commission of 10 percent, you calculate pay using this formula:

Total amount sold x Commission percentage = Gross pay

$60,000 x 0.10 = $6,000

For a salesperson with a guaranteed base salary of $2,000 plus an additional 5 percent commission on all products sold, you calculate pay using this formula:

Base salary + (Total amount sold x Commission percentage) = Gross pay

$2,000 + ($60,000 x 0.05) = $5,000

Although this employee may be happier having a base salary he can count on each month, he actually makes less with a base salary because the commission rate is so much lower. By selling $60,000 worth of products he made only $3,000 in commission at 5 percent.

Without the base pay, he would have made 10 percent on the $60,000 or $6,000, so he actually got paid $1,000 less with a base pay structure that includes a lower commission pay rate.

If he has a slow sales month of just $30,000 worth of products sold, his pay would be:

$30,000 x 0.10 = $3,000 on straight commission of 10 percent

and

$30,000 x 0.05 = $1,500 plus $2,000 base salary, or $3,500

For a slow month, the salesperson would make more money with the base salary rather than the higher commission rate.

There are many other ways to calculate commissions. One common way is to offer higher commissions on higher levels of sales. Using the figures in this example, this type of pay system encourages salespeople to keep their sales levels over $30,000 to get the best commission rate.

With a graduated commission scale, a salesperson can make a straight commission of 5 percent on his first $10,000 in sales, then 7 percent on his next $20,000, and finally 10 percent on anything over $30,000. Here’s what his gross pay calculation looks like using this commission pay scale:

($10,000 x 0.05) + ($20,000 x 0.07) + ($30,000 x 0.10) = $4,900 Gross pay

One other type of commission pay system involves a base salary plus tips. This method is common in restaurant settings in which servers receive between $2.50 and $5 per hour plus tips.

Businesses that pay less than minimum wage must prove that their employees make at least minimum wage when tips are accounted for. Today, that’s relatively easy to prove because most people pay their bills with credit cards and include tips on their bills. Businesses can then come up with an average tip rate using that credit-card data.

Employees must report tips to their employers on an IRS Form 4070, Employee’s Report of Tips to Employer, which is part of IRS Publication 1244, “Employees Daily Record of Tips and Report to Employer.”

If your employees receive tips and you want to supply the necessary paperwork, you can download it. The publication provides details about what the IRS expects you and your employees to do if they work in an environment where tipping is common.

As an employer, you must report an employee’s gross taxable wages based on salary plus tips. Here’s how you calculate gross taxable wages for an employee whose earnings are based on tips and wages:

Base wage + Tips = Gross taxable wages

($3 x 40 hours per week) + $300 = $420

If your employees are paid using a combination of base wage plus tips, you must be sure that your employees are earning at least the minimum wage rate of $7.25 per hour. Checking this employee’s gross wages, the hourly rate earned is $10.50 per hour.

Hourly wage = $10.50 ($420 / 40)

Taxes due are calculated on the base wage plus tips, so the check you prepare for the employee in this example is for the base wage minus any taxes due.

After calculating paychecks for all your employees, you prepare the payroll, make up the checks, and post the payroll to the books. In addition to Cash, many accounts are impacted by payroll, including:

  • Accrued Federal Withholding Payable, which is where you record the liability for future federal tax payments.

  • Accrued State Withholding Payable, which is where you record the liability for future state tax payments.

  • Accrued Employee Medical Insurance Payable, which is where you record the liability for future medical insurance premiums.

  • Accrued Employee Elective Insurance Payable, which is where you record the liability for miscellaneous insurance premiums, such as life or accident insurance.

When you post the payroll entry, you indicate the withdrawal of money from the Cash account as well as record liabilities for future cash payments that will be due for taxes and insurance payments.

Just for the purposes of giving you an example of the proper setup for a payroll journal entry, assume the total payroll is $10,000 with $1,000 set aside for each type of withholding payable. In reality, your numbers will be much different, and your payables will never all be the same. Here’s what your journal entry for posting payroll should look like:

Debit Credit
Salaries and Wages Expense $10,000
Accrued Federal Withholding Payable $1,000
Accrued State Withholding Payable $1,000
Accrued Medical Insurance Payable $1,000
Accrued Elective Insurance Payable $1,000
Cash $6,000

To record payroll for May 27, 2014.

In this entry, you increase the expense account for salaries and wages as well as all the accounts in which you accrue future obligations for taxes and employee insurance payments. You decrease the amount of the Cash account; when cash payments are made for the taxes and insurance payments in the future, you post those payments in the books.

Here’s an example of the entry you would post to the books after making the federal withholding tax payment:

Debit Credit
Accrued Federal Withholding Payable $1,000
Cash in Checking $1,000

To record the payment of May federal taxes for employees.