A Brief Introduction About the Commission Agreement
What Is A Commission?
Commissions can be a great way to incentivize performance as employees are in charge of how much they earn. Commissions can be paid as a percentage of the base salary, of the profits, or in any other way that may be agreed upon by the parties. The method of calculation of commissions is included in the agreement to avoid misunderstandings.
Payment of commissions is subject to the Federal Fair Labor Standard Act (FLSA) laws, and they should be kept in mind while entering into a commission agreement. While some jurisdictions allow it, laws in some jurisdictions prevent the payment of commission-only payment and require commissions to be paid in addition to a minimum wage. Local laws must be referred to before drafting the agreement.
When an employee works on commissions, whether that amounts to the entire remuneration or a part of it, a commission agreement is drawn between the employer and the employee in order to make the terms and conditions clear. Both parties to the contract benefit by entering into such a contract — the employee will have a concise overview of all the terms related to his employment, including the terms of payment of his commissions, and the employer can include non-disclosure and non-compete clauses to the benefit of his business. As with any contract, the primary purpose of it is to safeguard the interests of both contracting parties.
Who Takes the Commission Agreement? – People Involved
You would need to enter into a commission agreement if:
- You are an employee whose pay will be, in whole or in part, commission-based.
- You are an employer contracting with an employee whose pay will be commission-based, either in whole or in part.
The contracting parties here are the employee and the employer.
Purpose of the Commission Agreement – Why Do You Need It?
The purpose of a sales commission agreement is to:
- Lay down the terms and conditions of employment and to ensure both parties acknowledge them.
- Establish the relationship between the contracting parties as employer and employee.
- Detail the scope of the work expected.
- Detail the terms of remuneration, including the percentage of commissions to be paid, salaries (if any), the mode of payment, and any other benefits.
- Protect the interests of both contracting parties, making legal recourse an option in the event of a dispute.
Contents of the Commission Agreement – Inclusions
An effectively drafted commission agreement must be detailed and include the following terms:
- Effective Date: This mentions the date on which the agreement becomes effective. It is a standard yet critical clause that must be included.
- Parties to Contract: This clause identifies the parties to the contract, that is, the employer and employee. It must mention their names and addresses. If a party is a company, it must mention the legal name, legal form of the company, registration data, and fiscal identification number. If a party is an individual, the name, profession, address, and fiscal identification number must be mentioned.
- Employment: This clause details the scope of work expected and the duties the employee is required to perform in the capacity of being an employee under the employer.
- Calculation of Commission: This term specifies how commissions will be calculated. The commission percentage mentioned here cannot be amended after ratification unless mutually agreed upon by the parties in writing.
- Payment: This clause specifies the terms of payment, including the percentage of commissions to be paid, salaries, and any other benefits.
- Termination: This clause specifies the circumstances under which the agreement may be terminated.
- Confidentiality and Non-Compete: Confidentiality provision ensures that any information that the employee is accessible to during the course of his employment must be treated confidential and not revealed to any other person, persons, or entity. The non-compete clause prevents the employee from engaging in business with competing firms in order to protect trade secrets and other assets of the employer.
- Governing Jurisdiction: This clause specifies the jurisdiction that will govern any disputes that may arise out of the agreement.
- State-specific Laws: Include any clauses and terms that may be required for compliance with state-specific laws and legislation.
- Signatures: This ratifies the document and is critical to the validity of the agreement. The date and place of signing must also be mentioned.
How to Draft the Commission Agreement?
The procedure to draft a sales commission agreement:
- Mention the effective date of the agreement, that is, the date on which the agreement will come into effect.
- Identify the contracting parties with their names and addresses.
- Establish the relationship between the parties.
- Detail the scope of the work expected, specifying the duties that the employee is expected to perform. A clause by which the employee can undertake to perform his duties to the best of his ability can be included.
- A clause that lays down the terms of remuneration of the employee must be included. It must specify the percentage of commission the employee will be paid, mode of payment, and other benefits, including salaries. It is preferable to express sums of money and percentages of commissions in figures as well as in words. It is standard procedure to mention the currencies of the remuneration as per ISO standard.
- Make provisions for confidentiality and non-disclosure to protect any privileged information that the employee might receive over the course of his employment from being disclosed to other persons or entities.
- Provisions for termination of the contract must be made such that the circumstances under which the agreement may be terminated are clearly expressed.
- The agreement must state the name of the jurisdiction that will govern the document and any disputes that arise from it.
- Have the parties to the contract sign it to signify acceptance of terms. The signature must specify the time and place of signing.
The terms of the contract must be negotiated such that it is mutually beneficial and agreeable to both parties, in order to avoid dissatisfaction that could possibly lead to disputes. The interests of both parties must be kept in mind while framing the document, and neither should be significantly disadvantaged or nourished at the expense of the other. Federal Fair Labor Standard Act (FLSA) laws must be consulted while making negotiations to ensure compliance. Non-compliance with FLSA laws can attract heavy fines and punishments.
Benefits & Drawbacks of the Commission Agreement
The benefits of having a sales commission agreement:
- Gives a clear overview of the terms and conditions involved, avoiding ambiguity and miscommunication.
- Commissions incentivize performance as employees are in charge of how much they earn based on their performance.
- Safeguards the interests of both parties.
- Makes legal recourse an option, should a dispute arise.
The drawbacks of having a sales commission agreement:
- The legal costs of framing the agreement must be borne by one or both of the parties.
- A poorly drafted agreement that does not comply with FLSA and other laws can cost the business a lot in terms of fines and punishments.
- Negotiations can take time.
[Also Read: Incentive Stock Options]
What Happens in Case of Violation?
In case the terms of the contract are breached by either party, the aggrieved party can resort to the legal resolution of the dispute, either by arbitration or conventional dispute resolution methods. Depending on how the agreement suggests disputes should be handled, the parties might be required to amicably settle the dispute internally or by alternate dispute resolution methods before going to court.
How Are Commissions Taxed?
The IRS considers commissions to be ‘supplemental wages,’ which are defined as wage payments to an employee other than his standard wage. Commissions are taxed depending on how the employer pays them. If the commissions are paid along with the regular wage or salary, the standard federal and state taxes apply. However, if the commissions are paid separately, it is taxed at a flat rate of 25% in addition to Social Security and Medicare deductions. More details about the taxation of commissions can be found in Publication 15 (Circular E) of the IRS(1).
A commission agreement protects the rights of employers and employees contracting on payment by commission basis. It lays down all the terms and conditions in a single document to avoid any confusion about them. Furthermore, it gives the parties confidence that the other will perform their duties as expected and that they have legal recourse in the case of non-performance. It is advisable to engage in such an agreement if you are looking to employ someone and pay them commissions for their work. It is essential to ensure compliance with local, state, and federal laws when drafting the document as non-compliance is punishable by fines and other punishments(2).