What is the difference between a bonus and a commission?

Bonuses, commissions, stock options… There are many different ways for businesses to compensate their employees. While they all serve the same purpose, which is to provide an incentive to employees, there are some significant differences between the different types of employee compensation. 

For businesses, understanding these differences is crucial to choosing the best way of compensating their workers. Two compensation methods that are frequently used in companies of any size are bonuses and commissions.

What is the difference between a commission and a bonus? Are commissions and bonuses taxed differently? What are the implications for payroll?

Generally speaking, a bonus is an additional payment that is made on top of an employee’s base salary. It can be paid either as a reward for a particular achievement, great performance, or as a sign of recognition to all (or at least to the majority of) employees.

Businesses can offer bonuses to incentivize prospective employees to join the company, recompense existing employees for outstanding performance, or express their gratitude to long-term employees and improve employee retention.

There are different types of bonus payments, including: 

• Signing bonus,

• Referral bonus,

• Retention bonus,

• Christmas bonus or end-of-the-year bonus,

• Holiday bonus,

• Sales bonus,

• Long-term service bonus, and 

• Performance bonus.

Additionally, a distinction can be made between discretionary and non-discretionary bonuses. Discretionary bonuses are not tied to predetermined criteria, but are offered at the employer’s discretion. Non-discretionary bonuses, on the other hand, are offered based on fixed criteria employees need to fulfill in order to get the bonus.

The term ‘commission’ is typically employed in the context of sales activities to refer to a premium paid to an employee for having hit (or even surpassed) his or her sales targets. The commission is usually calculated as a percentage of the sold amounts.

Employers can choose between different models of commission-based pay which are straight commission, variable commission, and base salary plus commission. Paying workers a straight commission means that pay is entirely based on their sales numbers— essentially there is no base salary.

The same goes for variable commission pay, the only difference being that the commission rate is different depending on the kind of sale. Under a salary-plus-commission scheme, on the other hand, employees earn a base salary which is topped up by a sales-based commission.

Commissions are typically offered in sales representative positions and in jobs in the real estate, insurance, and finance sector. A compensation strategy that is based on commissions means that employee pay is variable.

Businesses can have different reasons for offering additional pay. For instance, they may want to reward outstanding performance, boost employee morale, or attract qualified workers. But how to choose between commission-based pay and bonus-based pay?

Factors to consider in the decision-making process include:

• Is the employee involved in sales-related activities?

• What pay structure would work best with the company’s overall employee compensation strategy?

• Which type of compensation will best support the business’s goals?

• What is the available budget for providing additional pay?

• What performance metrics would be most suited to determine which employees receive a bonus/commission?

In any case, the chosen form of additional pay should be enough of an incentive to motivate employees to hit their targets, join the company’s ranks, or whatever it is the business is trying to achieve by offering additional pay.

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How bonuses and commissions are taxed varies from one country to the next. In the United States, for instance, both bonuses and commissions are considered taxable income, which means that employees have to pay income tax on the amount they receive in the form of a bonus or commission.

The amount of tax that must be withheld depends on the employee’s tax bracket, the earned amount, and the applicable tax laws. The tax rates that apply to bonuses and commissions may be different to other forms of income. In the United States, bonuses and commission count as supplemental pay and are taxed at a reduced rate of 22%.

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Every country has its own rules regarding the tax treatment of bonuses and commissions. The same goes for the implications bonus and commission pay has for payroll. In cases where commissions and bonuses are considered taxable income, employers usually have to report the paid amount to the tax authorities and withhold payroll taxes as they would for the employee’s base salary. Employees further need to report any bonus or commission pay they received in their annual tax return.

However, there are some exceptions to this principle, one of them being the United States. Depending on their employment status, workers who are paid based on commissions might have to manage their tax withholding and reporting individually.

Both commissions and bonuses are incentives employers offer to their employees to motivate them to meet or surpass certain goals and expectations. They are paid on top of an employee’s base salary and are often used in sales positions—although there are different types of bonuses that can be offered to all kinds of employees.

The key difference between a bonus and a commission is that the latter is always related to sales activities. While bonuses are also common in sales positions, they can take many different forms and also be offered as a reward or incentive to employees in non-sales positions. Bonuses and commissions also differ with regard to the payment structure which varies depending on the type of bonus or commission.