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What is commission pay?

By on November 7, 2019

Employees can be paid in several ways. Some get paid fixed salaries while others get hourly wages. Some are also paid on a commission basis. 

If you are paid a commission basis, you are considered to be on commission pay.  Some jobs, especially those in sales and marketing, offer commission pay as an employee’s sole earnings or as an addition to the base salary.  

What does commission mean?

To understand commission pay, you need to define the term commission. According to California Labor Code 204.1, commission is defined as compensation paid to any individual for the services they render in selling an employer’s services or products. 

The compensation usually depends on the value or amount of product or service sold. It can also be based on a % of profits made from sales. Commission is usually paid upon completion of a sales-related task. Commission pay is generally used as an incentive to boost worker productivity. When paid in addition to a worker’s salary, it can be included in an employee’s paycheck or paid separately (monthly or bi-monthly). 

Important: It is worth noting that commissions aren’t discretionary payments. Employers can’t decide to pay or withhold commission, as is the case with performance bonuses. What’s more, performance bonuses aren’t commissions even when they are computed as a % of profits or sales (like commission).

What is commission sales?

The term commission sales refers to sales transactions that generate commission. As a salesperson, you may not be entitled to a commission if you don’t meet certain predetermined goals i.e., selling products or services past a certain amount or selling more than “X” units of a product/service. 

Types of commission

Commission is usually categorized by how it is structured (calculated and paid). The main types include:

  • Base salary + commission
  • Straight commission
  • Residual commission
  • Draw against commission
  • Placement commission
  • Performance commission

a. Base salary + commission

This is arguably the most popular commission structure. Employees who earn this type of commission are guaranteed a base salary, whether they make a sale or not. If they sell, they get additional pay (commission), which is usually calculated as a % of the sales made over a certain period.

This type of commission is ideal for salespersons who wouldn’t want to go without pay because they haven’t sold anything over a given pay period. The base salary acts as a “cushion” during slow periods.

However, employers usually have the advantage of setting the base salary, which is usually low. The commission percentage also tends to be lower since salespersons have guaranteed income even if they don’t sell.

This commission structure can also act against an employee. When you are assured of earning even when you don’t do anything, you have less incentive to sell compared to an employee who depends on commission 100%.  

b. Straight commission

If you earn a straight commission, your entire salary/earnings is based on a % of sales you make. Straight commissions are ideal for seasoned salespersons who are assured of making sales. The commission percentage is usually higher compared to other types of commission. 

The overall compensation also tends to be higher for highly talented salespeople who don’t have a problem making sales. A straight commission can increase if a salesperson surpasses a predetermined goal.

c. Residual commission

This type of commission allows a salesperson to earn residual income (commission) from sales long after making an initial sale. This commission structure applies mostly to some sales professionals like insurance agents who sell products that can be renewed/bought again after a certain period (usually after a year). 

If the insurance agent introduces a client to an insurance company and that client renews their policy, the agent earns residual commission which is calculated as a percentage of the client’s premiums. The commission earnings continue every time a client renews a policy or buys another product.  In some cases, the residual commission can be earned long after a worker has stopped working.

d. Draw against commission

Workers who receive a straight commission can be allowed to borrow against their future commission at the start of a pay period. Their employer can allot a predetermined draw (amount), which must be paid back after a pay period or deducted from earnings. This commission structure comes with risk if a worker doesn’t earn anything during a pay period. 

e. Placement commission

This type of commission is set. You are guaranteed a fixed amount for every sale you make. The essence of this commission structure is to encourage volume sales. Salespersons earn higher by selling more units.

f. Performance commission

This commission structure is characterized by revenue tiers that must be broken to earn a commission increase. A performance commission may or may not include a base salary or retainer. 

There are many other types of commissions. As a salesman, the most important thing is understanding your compensation package before accepting a sales or marketing role.

How to calculate commission

Commission can be calculated in many ways. The most common include:

  1. Commission as a percentage of price: Commission is commonly calculated as a percentage of the price a consumer pays for goods or services. 
  2. Commission as a percentage of profit: Commission can also be calculated as a percentage of the profit made after selling goods or services. This type of commission computation encourages salespeople to sell products/services at the highest possible price. 
  3. Fixed commission per sale: As the name suggests, this commission remains fixed (the same) for every sale made. For salespersons to make hefty commissions, they must sell more units of an item or service. 
  4. Mixed agreement: Commission can also be calculated based on many variables i.e., based on the number of sales as well as total sales.  
  5. Fixed floor commission: In fixed-floor commission calculations, salespersons are given a minimum payment per sale, such as a specific amount or specific percentage of profit generated from the sale, whichever is higher. 

There are other methods of calculating commissions that vary from one employer/company to another. As mentioned above, the most important thing is understanding your commission package, which should be detailed in your commission agreement.

Deductions from commissions

Can your employer make deductions on your commission?

California labor law code 221 prohibits employers from deducting from employee wages for expenses incurred doing business. In most cases, employers can’t make deductions for losses unless the employer finds the business loss to be as a result of culpable negligence, a willful or dishonest act on the part of the employees. 

This rule protects employees from employers who would want to deduct employee remuneration to cater to cash shortages in the business, among other operational problems like loss of equipment, breakage, or other business expenditure/losses arising from an employee’s actions.

Important: A commission agreement may authorize deductions on an employee’s commission for costs incurred in direct relation to a sale. For example, shipping costs and the cost of free samples included in a sale can be deducted. However, they must be tied directly to the sale. Also, an employer shouldn’t use deductions to shift the costs of doing business to an employee. For example, an employer can’t deduct general overheads like utility bills from an employee’s commission. Most importantly, any deductions made from an employee’s commission must be stated clearly in writing.

Can an employer deduct commission because of a product that is returned?

Yes. An employee can get into a commission agreement that makes commission payable based on events occurring after a sale. In such an agreement, an employee may be required to refund commission for products that are returned by a customer for whatever reason. Wages or advances given to an employer can also be recovered later if a sale is reversed for reasons like a bounced check.  

However, your commission can’t be deducted because of returns that aren’t directly attributed to you. Unless an employer is able to identify a sale to have originated from a specific salesperson, they can’t make deductions for returns from such as a sale.

Can advances be deducted from commission?

An employee can sign commission agreements allowing an employer to pay them an advance on commission wages that haven’t been earned. Some agreements may treat such advances or draws as compensation if the commission earned fails to reach a certain threshold. 

Generally, employees are required to repay advances if they don’t earn commission that equals or exceeds the advanced/drawn amount. Such advances are treated as loans that must be paid back. However, employers shouldn’t require employees to repay as a way of transferring business costs to employees. 

If an employee signs a commission agreement that doesn’t require them to repay advances that aren’t covered by commissions, such advances are treated as wages as opposed to loans. As a result, employees can’t be compelled to repay. 

In a nutshell, employees must have commission agreements in writing. It is highly unlikely for a court to compel an employee to repay employer advances unless it is explicitly required in the commission agreement.  

Can commission be deducted if wages fall below the California minimum wage?

Most employees in California who work on commission basis have a right to be paid in accordance with California minimum wage requirements. As a result, an employer can’t require an employee to repay advances or commissions if doing so will make their wages fall below the required standard. This applies unless an employee is exempt. 

Commission-based employees’ right to overtime

Apart from outside salespersons (salespersons who spend over 50% of their work time away from an employer’s premises), commission-based employees are usually entitled to overtime. This applies as per Labor Code 510 if an employee works over 8 hours daily, over 40 hours weekly or over 6 days consecutively during a workweek. Outside salespersons are excluded from overtime and minimum wage laws as per Labor Code 1171

The right to overtime pay is independent. Employers should pay eligible employees commission and overtime pay. Employees who don’t qualify for overtime (exempt employees) don’t have the right to overtime even if they receive commissions. 

FAQs about commission in California

1. How is commission taxed?

Employers are supposed to withhold income tax from their employee’s pay. Tax is also withheld on other income, including bonuses and commissions. According to the IRS your salary and commissions qualify as taxable income taxable at a rate depending on your filing status or tax bracket.  

2. What does the law say about unpaid commission?

The employment contract dictates when commissions are earned. However, California labor laws take precedence in regards to when commissions must be paid. Although there are exceptions, such as when car salespeople are supposed to be paid in California as per Labor Code 204.1 (i.e., once a month), commissions should be paid twice or more times during a calendar month. 

Generally, commissions are payable during the 1st pay period when earned commission can be calculated. According to the DLSE, commissions are considered earned if the information used to calculate them is available. 

3. I have been terminated. What happens to the commission I have earned?

According to Labor Code 201, if an employee is discharged or terminated, any wages they have earned but haven’t received are due as well as payable immediately.  The same applies to employees who quit/resign, provided they offer a notice 72 hours before their last working day as per Labor Code 202

However, these rules are subject to the fact that commissions aren’t considered payable if they can’t be calculated. If an employer refuses to pay commission willfully after terminating employment or when an employee resigns, the employee has a right to wages and assumed to continue working for a limited time as per Labor Code 203. The period in question (running for a maximum of 30 days) commences when the payment is first due until when it is paid.  

4. Can my employer change the commission agreement?

No. Employers can’t rewrite commission agreements. Once you make a sale under an agreement, the terms can’t be changed. Most employers who are sued because of commission-related issues find themselves in court because they attempt to change commission agreements. Generally, courts don’t uphold this. 

Employers may have the powers to change commission plans. However, there are limits. Terms agreed with employees can’t be overruled by new commission plans made periodically for whatever reason. If new contracts are interpreted to deny employees earned commission, courts usually rule in favor of employees. 

5. How much commission does a realtor make?

Realtors or real estate agents earn commissions that are agreed with brokers. The commission is usually percentage-based and varies depending on many factors such as selling price and location/state. In California, realtor commissions are negotiable between brokers and sellers, according to CAR (California Association of Realtors). 

6. How much commission does a car salesman make?

A car salesman’s commission also varies like that of a realtor. However, it is mostly based on a percentage of the profit in regard to new car sales. The amount can also vary depending on applicable deductions.

7. What should be included in a commission agreement?

All commission agreements must have a clear description of how commission will be calculated and paid. The agreement must also have clear descriptions of deductibles that an employer intends to deduct from earn commission. 

If an employee is entitled to an advance or a draw, the agreement should state clearly if such payments are repayable in case they aren’t earned as a commission. Commission agreements are written agreements. If an employer is “silent” about repayment of advance or draw, such amounts will be assumed to be general wages in case of a dispute. 

An employee must understand exactly what they are expected to receive as commissions as well as when the right to payment accrues.

8. What will happen if I continue working after my contract has expired?

If a commission agreement expires but an employer continues working with an employee, the terms stipulated in the expired contract remain in force until a new commission agreement is signed. An expired agreement can also remain in force until an employment relationship ceases to exist because of termination or resignation. 

9. How do I get unpaid commission in California?

California labor laws protect employees who are denied commission. If your current or present employer violates your commission agreement with them, you can file a DLSE wage claim

You can also sue your employer. You’ll need a good California employment lawyer to do this. The importance of seeking legal advice/help can’t be overlooked, given the complexity of commission-based cases. A good lawyer will be able to evaluate your claims and advise accordingly. You could even be enjoined in a class action suit with other workers in a similar situation.

10. I am paid solely on commission basis. I am eligible for rest breaks?

Employees who are paid solely on commission basis qualify for rest breaks. A past court of Appeal verdict has held California’s employee right to rest breaks even in the absence of a wage/salary. Rest periods don’t contribute to an employee’s commission, making them similar to other nonproductive time. However, employers must compensate employees accordingly to comply with wage and break regulations.  

11. When am I supposed to sue my employer for commission related issues?

If you close a deal that you are not compensated for accordingly, you are justified to sue your employer. Other actions by your employer that warrant a lawsuit include partial or complete withholding of commissions, or if you are fired or you resign before you are paid accrued commission. If your employer changes terms in your commission agreement after you close a deal, you can also sue. 

You can also sue if you are sidelined. If you participate in critical aspects of closing a deal, such as coordinating, arranging meetings, or handling most aspects of a sale, you can sue your employer if you are not paid a proportion of the commission. Any violation of an existing commission agreement warrants legal action. However, it’s advisable to consult an employment lawyer to assess the viability of your case individually or as a class action suit. 

12. Can my case be a class action suit?

In most cases, unpaid commissions don’t warrant employees hiring lawyers individually. Small commission claims are best pursued as class action suits. If you are not the only employee with unpaid commission claims, you have grounds for a big lawsuit that justifies hiring a lawyer. Under many state laws, including California, commission cases qualify for class-action status.

13. I have been denied commission, but I don’t have a commission agreement. What do I do?

If there is no contract between you and your employer or the terms are unclear, communication evidence can help in determining a commission dispute. For example, if you contacted your employer in the past about a specific sales commission and your employer indicated that they were waiting to receive payment before they pay you a commission, such communication can constitute as evidence. This can apply even if a written agreement is missing. 

14. There is an unfair clause in my commission agreement. Can the court rule in my favor?

Under California labor law, the court can determine that certain clauses in a commission agreement aren’t enforceable. In such a case, the clause/s can be “stricken out” from the agreement or disregarded. This is known as “doctrine of unconscionability”. 

Unconscionability claims are common when commission plans require an employee to be employed currently for them to be able to earn a commission. Such a clause is obviously unfair to an employee seeking accrued commission after being laid off. 

Under the doctrine, employers need to force an unfair clause on an employee by surprise or require the employee to act on a “take it” or “leave it” basis. In California, unfair clauses are rarely upheld. In other states like Texas, contracts are enforced to the letter regardless of the circumstances that led to making such contracts. Unconscionability claims are challenging to defend. The need for a seasoned employment lawyer can’t be overemphasized. 

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