The complete guide to employee compensation

Straight salary | Salary plus commission | Hourly | Hourly plus commission  | Commission-only | Territory volume | Profit margin/revenue-based | Residual commission | Contractor commission | Hourly vs Salary

When it comes to employee compensation, there isn’t a one-size-fits-all solution. The right plan will not only motivate your workforce, but it will also align with your business goals and profitability.

So what is compensation? Is it just monetary? Are benefits included in the definition?

In my experience, both in the corporate (salary) and retail (hourly) space, an employee compensation plan encompasses salary or hourly pay and any benefits added to the package.

How to find a balance between employee pay and benefits

Companies often feel they can justify a lower salary or rate if they include a more robust benefits package. These can range from monetary benefits (like extra paid time off, holiday pay, and parental leave) to lifestyle benefits (like flexible working hours, the ability to work from home, a pet-friendly working environment, etc.).

Some of this is likely due to a generational shift in what employees are really looking for. For post-Depression-era baby boomers, the security of a steady salary is important. Many millennials, however, are more focused on work-life balance and lifestyle plans, valuing more vacation or the freedom to work from home.

What are the most popular types of compensation packages?

Employers have to think about who their target employee is and what that employee is looking for. Are they just trying to pay their way through college? If so, an hourly rate with a flexible schedule could be more attractive. If they’ve just started a family, they may be looking for benefits like parental leave and the chance to work from home. It’s critical for employers to keep this in mind when deciding between different types of compensation packages.

The nine different types of compensation packages include:

  1. Straight salary
  2. Salary plus commission
  3. Hourly
  4. Hourly plus commission
  5. Commission-only
  6. Territory volume
  7. Profit margin/revenue-based
  8. Residual commission
  9. Contractor commission

1. Straight salary compensation

This type of compensation refers to a set annual amount, divided by the year’s pay periods to get a pay rate weekly, every two weeks, or monthly. There is no additional performance or sales-based income added to the employee’s compensation.

Salaried workers who earn more than $23,660 per year are considered “exempt” under the Fair Labor Standards Act (FLSA). Therefore, employers are not required to pay overtime if employees work more than 40 hours per week. As a result, salaried workers often don’t track hours worked. A job like this is more likely to have flexible working hours or the ability to work from home.

Who’s using straight salary compensation?

Straight salary compensation plans are ideal in industries where the normal structure does not involve (and might even prohibit) direct sales. Companies with employees who work in teams, spend a lot of time on projects, or whose performance is difficult to measure might also be better suited for straight salary compensation.

Teams in human resources, graphic design, or other supportive departments will often use straight salary compensation. Companies looking for long-term growth as opposed to short-term sales may opt for this type of compensation as well. It can also be beneficial if a firm is entering a new market or location.

Benefits of straight salary compensation

Companies looking for a simple or consistent payroll solution without any surprise payroll expenses will likely build their compensation offering around straight salaries. Employees who like to work on teams and don’t want their compensation to be judged on individual performance may be attracted to this kind of plan as well. Straight salary offerings can also be good for attracting new talent that’s concerned with stability.

Disadvantages of straight salary compensation

Some disadvantages of straight salary compensation may include reduced retention and high turnover if employees don’t see opportunities to increase their pay. Since there are no (monetary) incentives to work harder, a non-competitive environment may tempt employees to become complacent, limiting the company’s growth. It could be difficult to attract top performers who know they can make more in a job that rewards their work with a more commission-based pay structure.

Of course, there are exceptions to every rule. Salaried individuals who earn less than $23,660 per year often qualify for additional compensation, including overtime pay, per the FLSA’s standard for non-exempt salaried employees. In this situation, employers have to pay overtime, despite the employee being salaried. Laws differ by state, so do your research before making any decisions.

2. Salary plus commission compensation

Salary plus commission is a balance of both stability and performance-based income. Similar to straight salary, this compensation structure offers employees a guaranteed base income annually, but also offers performance-based income in addition, unlike straight salary.

The commission can include (but is not limited to) a percentage of personal sales, a percentage of team sales, bonuses, or overtime pay. These plans often include a straight salary income for training periods or during low seasons. A good salary plus commission plan will motivate employees to higher sales and performance while giving them the peace of mind of regular, stable income.

Who’s using straight salary plus commission compensation?

Salary plus commission plans are often used for sales positions or corporate positions when the company wants to encourage leaders to push for substantial growth and high performance. It is critical that companies using this type of system have good metrics in place for tracking sales so they can fairly and accurately calculate commissions.

Benefits of salary plus commission compensation

One benefit, from the employer’s perspective, is the company only pays commissions when the top line improves, so it’s beneficial from a profitability standpoint. The salary-plus-commission pay structure also encourages employees to set more aggressive sales goals. Employees like it because it rewards those who work hard. Many appreciate the fallback stability of the base salary paired with performance incentives.

Disadvantages of salary plus commission compensation

From a payroll standpoint, this type of compensation is harder to administer. There may be multiple rates of bonuses and commission, and payroll managers must have a system in place to keep track of everything. Employees may be confused as to how pay is calculated, so transparency is important. One thing to keep in mind: If the commission rates are too low, they may seem disingenuous and could decrease morale or cause bitterness among employees. The key to this type of plan is to offer enough stability that employees feel satisfied and secure but to pair that salary with a commission that motivates stellar performance.

3. Straight hourly compensation

This type of compensation refers to a set hourly amount without additional performance-based income. Employees who receive it are considered “nonexempt” by the FLSA, meaning their compensation is regulated. One regulation is employers are required to pay overtime at a rate of time and a half if an employee works over 40 hours in one week (this is a U.S. standard and differs by country). Employers are also required to pay employees the minimum wage, which can vary depending on their state’s minimum wage.

Who’s using straight hourly compensation?

This type of compensation is often used for entry-level jobs or employees working in restaurants, retail, or the service industry, usually in non-management roles.

Hourly roles can often be perceived as less valuable or easier to replace. Because so many hourly employees work in entry-level positions, education requirements are usually lower than those of salaried positions, which adds to this assumption.

Benefits of straight hourly compensation

For employers, hourly employees can be a good option for work that fluctuates seasonally. Employees need not be scheduled for the same number of hours each week. Running payroll for hourly employees, as opposed to salaried employees, can also be significantly cheaper, making it easier for companies to hit financial goals. Employees who also have seasonal or fluctuating availability, like students or people with children, also benefit from the flexibility that comes from hourly compensated positions.

Disadvantages of straight hourly compensation

It’s worth noting that inconsistent working hours can also hurt employees who may be counting on a consistent income. This can lead to high turnover, a need for more recruitment resources, and higher training costs—all of which cuts into potential bottom-line savings.

Another disadvantage is that hourly employees often have fewer benefits than salaried employees and are sometimes required to contribute more toward their health insurance premiums. They may have less vacation time or even zero paid vacation time.

Employers who pay by the hour should focus on increasing morale and showing employees they are valued in order to avoid turnover. For more information on your state’s minimum wage requirements, read up on minimum wage requirements or visit the Department of Labor’s website.

4. Hourly plus commission compensation

In this compensation structure, the employee receives a set hourly rate, plus a percentage of their sales. The hourly rate can be less than the required minimum wage. However, if the employee’s commissions, plus their hourly rate, are together less than the minimum wage, the employer is required to make up the difference. Similar to hourly employees, workers who are paid with this type of compensation are usually governed by the FLSA’s nonexempt requirements and earn overtime.

Who’s using hourly plus commission compensation

Such positions might include retail sales, restaurant employees, barbers and cosmetologists, and customer service reps. Employers may use this type of compensation to keep payroll expenses low while still motivating employees to perform.

This compensation category also includes restaurant employees paid mostly in tips. Defined by the FLSA, “tipped employees” are those who receive more than $30 per month in tips. Tips may be considered part of the employee’s wages, but the employer must pay no less than $2.13 an hour in direct wages and make sure that the amount of tips received is enough to meet the remainder of the hourly minimum wage.

Benefits of hourly plus commission compensation

Employees who are self-motivated and hardworking are attracted to this type of work because there’s typically no upper limit to the amount in tips or commission they can take home. Some of these jobs also have flexible schedules, which can be beneficial to employees. In addition, employers also enjoy the flexibility of being able to increase or decrease employee hours seasonally or to reflect sales growth.a

Disadvantages of hourly plus commission compensation

Hourly plus commission compensation does have its disadvantages as well. Because employee base pay is often low (employers can pay as low as $2.13 hour, which means the entire paycheck can go to taxes or withholding), making a livable income can be tough without significant sales. And while some competition in the workplace is good, this kind of motivation to not only succeed but to survive can sometimes breed distrust and a lack of camaraderie.

5. Commission-only compensation

In this type of compensation, income is solely based on sales made. Commission-only compensation plans are usually simpler and easier on payroll than compensation types combined with hourly or salary pay rates.

Who’s using commission-only compensation

Commission-only compensation can be valuable for employers because top performers get the most money. It is often used in direct sales industries and multi-level marketing (MLM) firms that work with independent contractors.

This compensation type tends to attract fewer people since there is no secure base pay. Employees who are eager and top-performing are often attracted to this type of commission, however, since they know they can survive solely on their skills and experience.

Benefits of commission-only compensation

Employees who prefer to set their own schedules or be their own boss often thrive in commission-only environments. From a morale perspective, they can be more satisfied with their work-life balance since no one is dictating it.

Disadvantages of commission-only compensation

Purely paid-by-commission plans can create an unfriendly, competitive environment within teams. And because there is no financial security that kicks in if sales aren’t made, those who don’t earn enough leave or burn out quickly.

6. Territory volume compensation

In territory value compensation (TVC), payment is calculated based on the territory volume at the end of a period. Total sales for the territory are then split among the sales reps in that territory. This requires very clearly defined territory outlines and territories that produce enough income to support competitive wages.

Who’s using territory volume compensation

TVC is most often used in team-based corporate cultures. The sales teams support each other to reach a common goal. Corporate industries and IT sales, for example, often use this type of compensation when creating bonus plans. In this situation, employees only receive their bonus if the district, division, or even continent hits its sales goals.

Benefits of territory volume compensation

Employees who like working in sales but also in a team environment will be attracted to such compensation, as it takes the pressure off the individual’s performance.

Disadvantages of territory volume compensation

On the other hand, TVC can lead to hostility between employees if they don’t feel the workload or efforts of all representatives are balanced.

7. Profit margin/revenue-based compensation

In a profit margin/revenue-based (PMR) plan, employees are compensated based on the profitability of the company.

Who’s using profit margin/revenue-based compensation

PMR is common in sales and is good for startups with low liquidity.

Benefits of profit margin/revenue-based compensation

PMR-based compensation often encourages loyalty among employees, but it will also require long-term incentives to retain talent. This type of environment tends to foster a sense of camaraderie and can be good for company culture and morale if done well.

Disadvantages of profit margin/revenue-based compensation

Due to the complexity of the plan and its many compliance issues, few companies offer equity or stock in the short-term. Companies that pay their employees using PMR-based compensation will want to offer additional benefits to make up for their potentially low liquidity.

8. Residual commission compensation

The salesperson’s perfect plan, a residual commission compensation (RCC) plan pays employees a commission as long as the accounts are producing revenue. Even if the employee no longer does work on the account, so long as the account continues to perform, the employee will receive a cut of the profits.

Who’s using residual commission compensation

This type of plan is often found in multi-level marketing (MLM) companies. Motivated salespeople may search for this type of income, knowing that if they work really hard early on, they can work less later and still make the same income.

Benefits of residual commission compensation

If it’s part of their contract, salespeople can continue to receive commissions even after they’ve left the company. For employers who don’t want to pay employees after they leave, this type of compensation can incentivize employees to stay at the company.

Disadvantages of residual commission compensation

Employers are often hesitant to use this type of compensation, as payroll expenses can be high or unpredictable.

9. Contractor commission compensation

This is a very broad category of compensation. As defined by the IRS, independent contractors are people who “are in an independent trade, business, or profession in which they offer their services to the general public.” Employees and independent contractors are mutually exclusive, as a person is either one or the other.

Per the IRS website, the general rule is that “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to self-employment tax.”

This is a very important distinction, as it determines who pays the taxes (the worker, not the employer) and to what standard an employer is held.

Who’s using contractor commission

The independent contractor category is broad and includes everything from lawn services to sales to doctors and lawyers.

Commission for independent sales reps can range from 5% to 40%, with the average ranging from 20% to 30% of gross margins or 7% to 15% of gross sales. Factors that might affect commission rates include the difficulty of the sale, education and training required, costs associated with the geographical location, work environment, the process of approaching clients, and bonus structures (if applicable).

Benefits of contractor commission

Working as a contractor definitely has its benefits. Per the IRS definition, the contractor is in control of how the work gets done, so there is a lot of freedom. Contractors can determine their own fees, working hours, employees, etc. Additionally, they have full control over benefits like insurance and retirement management. Because they are self-employed, contractors are eligible for SEP IRAs. These have a significantly higher (pre-tax) contribution limit than company IRAs.

Disadvantages of contractor commission

In the same vein, contractors are not subject to withholding and are therefore responsible for their own taxes (the self-employment tax). Since no one is taking out taxes for them, it is up to the contractor to budget and remit taxes quarterly to prevent a fine and a huge tax bill at year-end (April 15). Another disadvantage is the lack of benefits. Contractors are required to find health insurance and retirement plans on their own.

Pros and cons of salaried versus hourly compensation

Depending on a company’s compensation strategy, there are both pros and cons for hourly versus salaried employees.

Pros of hourly compensation for employees

  • Overtime and holiday pay
  • The freedom to change work schedules in accordance with other schedules
  • The opportunity to work more hours to make more money
  • It’s often easier to get a new job if the current one isn’t a good fit

Cons of hourly compensation for employees

  • Hours can be inconsistent
  • Lack of security
  • Generally lower pay
  • Fewer or no benefits

Pros of hourly compensation for employers

  • Employers can increase or decrease hours based on heavy or slow seasons
  • Depending on how many employees are on the payroll, employers may not be required to provide benefits, including health insurance or PTO
  • Often lower payroll costs

Cons of hourly compensation for employers

  • Payroll can be more complex and difficult to calculate if using multiple rates
  • High turnover
  • Increased training and hiring expenses (as a result of high turnover)

Pros of salary compensation for employees

  • Consistent hours and income create more security
  • Better benefits
  • Often more flexible working hours
  • Often more opportunity to work from home

Cons of salary compensation for employees

  • If working for a straight salary, better performance doesn’t constitute higher pay
  • No monetary incentives to work harder
  • Switching between jobs can be more difficult, as there’s often a more intense hiring process

Pros of salary compensation for employers

  • Consistent payroll workload and expenses
  • Often higher retention rates
  • Salaried employees can be more loyal than hourly employees
  • Often a higher level of talent or education

Cons of salary compensation for employers

  • Payroll expenses are fixed, even if profitability decreases
  • Hiring can be more complex
  • It can be more expensive to attract top talent

Why employee classification is so important

The Department of Labor has very specific requirements for classifying and paying employees. Before making any decisions, consider what type of compensation you can offer potential employees and what the stipulations of that compensation plan are.

To ensure proper classification, employers should begin with the assumption that their commissioned employees are nonexempt, and then review the potential exemptions to determine whether they apply. The most common exemptions are executive, administrative, and professional exemptions. In fields that typically involve commissions, the outside sales exemption and the retail sales exemption may also apply.

About the author

Katey Maddux is a paddle boarder, music lover, Zumba instructor, and Founder and CEO of Millennial Accounting, LLC in Miami, Florida. She loves training, creating processes, and introducing her clientele to new apps and technology. Millennial Accounting primarily serves two niches—real estate and property management—and is on a mission to serve, inspire, educate, and problem-solve.

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