When there's a delay between the time your salesperson gets a signed contract with a customer and when the customer actually pays, some companies offer the salesperson advances on her commission payment. They pay the salesperson full or partial commissions before the sale is considered final. If the sale falls through, however, the company can deduct the advance commissions from future paychecks.
Why Give Advances?
Many salespeople find motivation in commissions. However, when the product or service they sell doesn't actually earn a commission until six months later, salespeople might lose some spark by not seeing the immediate gratification in their paychecks. Because of this, many companies choose to provide partial or full commission advances immediately. This also helps the salesperson calculate her expected income each month and keep money flowing in during seasonal market changes. When sales fall through later on, the salesperson no longer earned that commission, which means you must have a way of deducting the amount of the advances from base salaries.
When you offer advances to salespeople, explain the conditions clearly and on paper, then get the employees to sign stating they understand and agree to the conditions. Give the time frame or conditions that make a sale final. For example, if the entire amount due must be paid in full within three months of the original transaction date, spell that out. Any commissions paid to the salesperson before the sale is final should be called "advances" so there's no confusion as to whether the payments should be considered wages. When the sale is final and the commission is earned, the commission is then taxable as wages. Advances typically are not taxable until the commission is considered earned. If a sale falls through, state in the commission contract that employees agree to have advance commission payments automatically deducted from future wages. Also, spell out any duties expected of the salesperson to ensure the sale ends up complete, such as troubleshooting problems for the customer or calling to collect payments during a specific time frame.
Pay Taxes Later
To keep deductions of previous commission advances neat and clean, deduct the same amount you advanced the salesperson from his base salary. Taxes aren't due on commissions until they're earned. This means when you pay an advance, you can pay 100 percent of the amount. When the commission is earned, you take out taxes on that amount, even if it's months after the commission was paid. To deduct advances, subtract the exact amount of the commission from the employee's base salary so there's no question of what was paid and what was subtracted, and there's no concern about overpaying or underpaying income taxes.
Deductions in Writing
When you must deduct commission advances from a salesperson's salary, put everything in writing. It's never a good idea to hand someone a paycheck that's less than he expects without explanation. Instead, include a letter with the paycheck that states which sale fell through, when the original advance was given, and how much was deducted from the current paycheck. Provide as much detail as possible. For example, suppose you notified the salesperson three times about non-payment by the customer, but the salesperson never followed up. Include that information -- along with dates and the manner of notification, such as email -- and refer back to the signed agreement that states it's the salesperson's job to complete the sale. This helps protect you from legal action. In some states, you can't deduct earned wages, so make it clear throughout the process that you're deducting an advance, not earned wages.