Earned Income (W-2) vs. loan to employee

[billwilliams70806]

Message:
I have a client who has worked as a commissioned salesman for over two years--he is paid as he sells--for the first year or so he was "advanced" commissions and a running total of advance vs. earned was kept by the employer//his commission was 9%//the employer has stopped the commission advance & now takes one-half of commissions earned in repayment of the debit balance--effectively reducing commissions to 4 1/2%---

The problem comes in for 2007 as the balance due to employer was approx. $13000 & earned was $33000 = $46000//the employer issued a W-2 in the amount of the $46000 & continues to take the $13000 from current commissions//therefore the employer has a payroll expense deduction & is getting his $$ back//my client believes he should have gotten a W-2 for only the $33000//I agree--

Any thoughts.........Please respond.

Bill Williams

[thomtax]

Question

My question is "Did the employee receive a W2 and pay income taxes on the $13,000 when he received the draw?"

If he did not, what is his reasoning that he should not ever pay tax for getting this amount of money in income.

I would respectfully disagree with the premise that he is now only getting 4 1/2% commission. He is still getting the 9% commission. If he owed the bank and was paying them an amount equal to 4 1/2% of his commission, would he think that he should avoid paying taxes on this amount of money?

If the $13,000 was originally reported and he paid income tax on it, then that is a completely different scenario. That is the basis for my question at the start of this post.

LT

[JohnH]

I agree.
The treatment of the $13,000 by both the employer and the employee is crucial to the answer. (Although there was really only one way to handle it properly in the first place)

[DaveO]

In another lifetime

I managed large sales teams (If herding sales people can be called management at all). The draw against commissions was used mostly when we treated the sales people as independent contractors. If someone left before paying back their draw a 1099 was issued for all paid commissions and all un-earned draw.

After a long and painfull battle with the IRS and various departments of labor we treated all sales people as employees, except for brokers and agents. After a couple weeks of training pay a base salary was paid subject to certain performance goals being met. A sales person could elect to drop the base pay and earn commissions on a higher scale.

In all cases any money paid to the employee sales person was taxable wages reported on a W-2.

[billwilliams70806]

Point of clarification

This situation took place all in 2007 --the earned commission was approx $33k-- the advance (unearned @ 12/31/07) was approx $13k (total paid = $46k) & W-2 was for $46k----------employer continues in 2008 to pay salesman 9% commisson and hold back 4.5% and deducts that from the $13k balance unearned at end of 2007-----looks like employer will try to issue W-2 in 2008 for 9% commission-------all advances have stopped.

Hope this helps---thanks to all who took time to respond--any further thoughts/

[Snaggletooth]

Constructive Receipt

With respect to unearned commissions - it is very common for a salesman to be advanced an entire year's commission when a policy is issued. If this occurs in November, for example, the salesman will have 10 months "unearned" commission by year end.

The doctrine of "constructive receipt" will tax the salesman on the entire commission in the year received. This means the salesman has effectively concluded his compensation arrangement even though there are unearned commissions involved.

However, if the salesman is an agency (this can be a proprietorship), his company can elect accrual basis accounting. If the advanced commission is subject to chargebacks, then the doctrine of constructive receipt is then defeated. I would think that the salesman/agent would receive a 1099 and not a W-2 in this case. The 1099 would equal the accrual basis (earned commission) income. Under this arrangement, if the agent quits his relationship with insurance company, he will receive 1099 for income as calculated - in arrears of his departure.

For what it's worth, the insurance company only recognizes income as it is earned. They have zillions of dollars on their balance sheet shown as a liability for unearned income. But of course, they are not an individual, and they are on accrual basis accounting.

[OtisMozzetti]

Repayment of Income Received in Prior Year

We might want to compare this with another sort of REPAYMENT of income received (and taxed) in a prior year:

If unemployment compensation has to be REPAID, then it may be netted off if during the current year, but for a prior year it is an itemized deduction on Line 23 of Sch. A. However, if the amount repaid is more than $3000, then the REPAYMENT gives rise to a tax credit for the difference in tax which the income caused in the prior year.

Maybe a repayment of W-2 wages can receive similar treatment? Yes, indeed look in Publication #17, page 85, under the subject of "Repayments".

[billwilliams70806]

Thanks

Thank you Gentlemen for your replies--it is ALWAYS good to get 2nd opinions.