How to Calculate Severance For Commission-Based Workers
June 07, 2018 by Josh Hrala
Severance agreements are a great way to protect your organization from a wrongful termination lawsuit by having the outbound employee sign the document and waive their chances of taking you to court for a lump sum severance payment and other benefits.
Of course, you know all of that already, but how do you know what to pay outgoing workers? Should there be a blanket payment that is offered to everyone? Should you base it off of their yearly pay?
Typically, severance payments are determined by the employee’s salary and their tenure at your organization. You can learn more about that type of severance payment scheme with our free resource here:
The big question is what to do with employees who depend on commission? How do you calculate severance for these individuals? Is it the same as others?
There are a lot of different ways, actually, which is good because it allows you to explore what works best for your organization.
Let’s take a look at a few.
Calculating Severance Based on a Standard Income
Because of the nature of commission-based pay structures, a lot of companies decide to look at the general income level for the role.
What’s that mean?
Let’s look at an example. If you have a sales person that sells medical equipment in the healthcare sector, you can go online and find what a typical, average salary is for those individuals looks like and then use that figure to offer severance to your sales person.
So, if the average salary for a salesperson in the healthcare field is $100,000 dollars, you should divide that up into months (around $8,300/month) and then use the employees tenure to determine how many months of that income they will receive.
Now, the problem with this method is that you may not be paying a salesperson that same amount of money for whatever reason. You could end up paying a ton of money that you don’t have just because you want to follow this schema.
The good news is that there are a bunch of other techniques that are more aligned with your business in general instead of the overall market.
Use Their Personal Average Salary
Instead of using the average salary of the role across the US, you can also just take their average salary and then do the same division that we did above to find out what their monthly severance payment might be.
This is far easier to calculate than to look at the overall salary of the role and also makes more sense because it’s based on their actual pay. Though some organizations do like to use the first option, it can be quite tricky to pull off and could cost you a lot more money than severance needs to.
By using the person’s salary, you also aren’t locked into a higher payment for other sales staff, too. If you are laying off an entire sales department and you need to provide severance to all of them, you don’t want to be paying a way higher rate than they were making.
There’s another way of doing this, too:
Severance Pay Based on Their Best Performing Months
When it comes to sales, it stands to reason that some months will bring a higher performance than others because, despite everyone’s best efforts, it can take some time to close a sale and that means that some months will have less commission than others.
Because of this, some organizations pay severance based on only the good months because it’s a more accurate representation of the salesperson’s efforts. By looking at a yearly average, you can actually punish the sales person for the bad months, which just isn’t how sales should work.
So, if you want to do something a bit different, take only their best months and make an average out of that to come up with their monthly earnings and then calculate their severance based on their tenure and that number.
Do You Need to Pay Severance At All?
Even though there are many ways to calculate what payment you should go with, the real question – and the elephant in the room – is should you pay them at all?
For some organizations, they have a policy that says that only full-time employees, who have a W-2, get severance pay. This means that 1099 employees, who are contractors technically, do not get severance pay. Salespeople are typically 1099 employees, which means that many organizations have a policy to not pay them severance.
The fact of the matter is that you do not need to pay severance to anyone let go from your organization. There is no law that says you have to provide a severance agreement and the choice to do so is completely up to you.
However, providing one is a great idea because it protects your company from potential lawsuits down the road. It helps you cover your bases and keep going forward with your business even if you need to let someone go.
We recommend always providing severance agreements to outbound staff and also coupling their payment with outplacement services to make sure that your exiting staff member will not sue you and will be set up for success down the road.
Yes, besides protecting you, severance agreements should provide a benefit to the employee, too. Providing them payment to hold them over on their job hunt and also providing them outplacement to help with the search, you show the employee that you care about their future, which you should because they gave a lot of time to your organization and layoffs aren’t their fault.
Commission-Based Severance Payments: The Final Say
When it comes to paying severance to commission-based employees, organizations have a few options to choose from.
You can calculate the payment based on the average income that the role has across the country, you could calculate it based on the employee’s average salary, and you can calculate it by looking at their best months.
There is no legal need to offer severance payments to employees, either, though it’s definitely a good option because it keeps you protected from lawsuits and also shows your employee that you want to help them through their job hunt.
Remember, it’s vitally important that you lean on your legal team when discussing severance agreements and downsizing events to make sure you are complying with all local, state, and federal laws.
If you want to learn more about calculating severance payments, check out our free calculator here:
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