For most people, working a job means trading your time and skills for money. Many companies hire employees and pay them a fixed annual salary or hourly wage. But, for real estate agents and others who work in sales, compensation may come exclusively from earning commission.
There are many differences between a salary and commission, from income predictability to tax implications and earnings potential. Both salaried and commission jobs come with their own set of pros and cons. For some individuals, a salaried job might be a better fit for their lifestyle, whereas others might find the higher earnings potential and flexibility of commission more appealing.
Regardless of your compensation structure, understanding the differences between salary and commission is important, particularly if you’re a newer real estate agent.
How does salary work?
A salary is a fixed payment an employee receives in exchange for their work. Salary is usually offered on an annual basis and paid out biweekly. If you earn a salary, you can expect your paychecks to remain consistent. For example, if you earn a $52,000 annual salary, you’ll receive $2,000 bi-weekly before accounting for deductions for tax withholding (which we’ll discuss later in this article), health insurance premiums, or contributions to retirement accounts and health savings accounts.
The primary benefit of a salary is that you know how much you’re going to make
Tax implications of salary
Employees on salary (part-time or full-time) must complete Form W-4, also known as the employee’s withholding certificate, and return it to their employer. This form includes the employee’s name, address, social security number and filing status (i.e., – whether the employee is filing as a single person, or jointly as a married couple) and information about the employee’s income. The purpose of a W-4 is to instruct the employer to set aside (aka withhold) the appropriate amount of money from the employee’s paycheck for federal taxes.
The Internal Revenue Service (IRS) requires employers to file Form W-2 annually for each employee who earns more than $600. A W-2 contains detailed information about an employee’s compensation, which is filed with the IRS and Social Security Administration, and shared with the employee. Employees and their tax professionals will then use their completed Form W-2 to prepare their federal and state tax returns.
If an employee’s W-4 accurately reflects their earnings for the year, they usually won’t have to worry about owing additional taxes. That’s because employers withhold tax monies and pay them directly to the federal and state government on behalf of their employees.
How does commission work?
In contrast to a salaried job, which offers consistent compensation throughout the employment term, commission offers performance-based pay. If you work on commission, you’re a self-employed, independent contractor, and you make money by earning a fee when you close a sale.
When you work on commission, there are no guarantees, but you’re also unencumbered by most limitations. While employees have to report to work at certain times and complete specific tasks, nonemployees on commission can set their schedules and do things their way. For independent contractors on commission, the sky is the limit. There’s no salary cap, no set hours, and no one to tell you what to do. That also means you’re responsible for running your business and making sure you close enough deals to support yourself. In addition, you have to budget appropriately, carefully managing your finances and saving for retirement while contending with income that can vary drastically from month to month.
Tax implications of commission
Nonemployees (aka independent contractors) who earn commission exceeding $600 annually must file IRS Form W-9. The purpose of a W-9 is to provide accurate information about an independent contractor’s tax information. When tax season rolls around, the business must file Form 1099-MISC with the IRS and send the completed 1099 to the independent contractor by the January 31st deadline.
When independent contractors earn commission, the business that pays them doesn’t withhold taxes or remit payment for them directly to the federal or state government. In other words, if you’re paid on commission, you have to set aside money to pay your taxes yourself. Since you’re considered self-employed by the IRS, you’ll also have to pay quarterly estimated tax payments (using Form 1040-ES). If you fail to make your quarterly estimated tax payments on time, you could end up paying the amount you owe at the end of the year, plus additional fees for late payments.
Though commission-based employees don’t have anyone to withhold taxes for them, self-employment does offer some tax perks. If you’re a self-employed real estate agent, you can claim tax write-offs for most of your business expenses. Deductible expenses include (but are not limited to) association dues, MLS dues, marketing costs, phone and internet bills, E&O insurance, and even the mileage you put on your car can contribute to a reduced tax burden.
Key Differences Between Salary & Commission
|You answer to a manager or boss||You are the boss|
|Stable, predictable payments||Unpredictable income|
|Easier to budget||Can make budgeting difficult|
|Limited earnings potential||Unlimited earnings potential|
|Taxes withheld by your employer||Must make quarterly estimated tax payments|
|Often includes benefits, such as retirement savings contributions, health insurance, paid time off and more||No benefits. Must save for retirement on your own, pay for your insurance, etc.|
|Set schedule||Flexible schedule|
|Limited tax write-offs||Can claim more tax deductions|
Both salaried and commission work have a distinct set of advantages and drawbacks. A salary is an easy choice for many people because they want predictable payments and financial stability. When you earn commission, your earnings potential is limitless, but you’re also responsible for operating your own business, and you have to deal with the ups and downs. Fortunately, if you’re a real estate agent, Tongo can help you weather the storm during those slow months by letting you tap into your pending commissions today. Self-employment can be difficult, but thanks to Tongo, accessing your pending commissions can help provide the stability you need to continue growing your business.