Chapter 17: Sales Compensation and Expense Allowance

Overview: This chapter looks at special sales compensation plans, including expense accounts and travel allowances. It examines the use of straight salaries, incentives and combination plans.

Corresponding course

76 Sales Compensation and Expense Allowances

INTRODUCTION

Not all employees are the same, nor are the jobs they hold. Some groups within an organization need special compensation systems in order to take advantage of the type of person that is attracted to that type of job and the special characteristics of the job. This chapter deals with one of these special groups: outside sales personnel.

SEPARATE COMPENSATION PROGRAMS

Compensation programs consist of a series of decisions that form a framework for rewarding employees for their participation and productivity, which result in the successful performance of the organization. Since each person is different, these decisions must be able to be applied in varying circumstances while retaining the consistency required for equity. In this way, the employment exchange is an individual exchange between the person and the organization, based upon the variations in perception of each. In some cases, groups of employees have similar circumstances and/or perceptions that have led organizations to develop compensation programs that contain enough special characteristics to be dealt with separately.

Different compensation programs for a group are based to some degree upon traditions within organizations and to a larger degree upon differences in the jobs and the people in these jobs. Jobs vary in measurability of their output and therefore in ease of establishing a clear measure of performance necessary for a variable pay program. Jobs also differ in their importance to organizational goals and therefore in the degree to which it is profitable to the organization to expend the energy necessary to develop special programs. Further, some jobs operate independently, so the identification of cause and effect is easier and more reasonable. In highly interdependent jobs there is a dysfunctional effect from creating competition. Finally, some jobs require a great deal of contact with individuals outside the organization, making the employee a representative of the organization. This often leads to a feeling within the organization that such a job has a special status.

People also vary in their expectations of what contributions they deem important. Much loyalty is expected of some groups, little of others. Although most people in organizations work in similar conditions, some work in such different circumstances that these particular circumstances are seen as an important part of the employment exchange. When these differences in jobs and their incumbents become great enough, organizations respond by specializing the compensation decisions for the group involved.

Some of these differences were recognized in the Fair Labor Standards Act (FLSA), which classified salespeople as "exempt." However, unlike other white collar exemptions, the exemption for salespersons is limited to outside salespersons. The rule is that the employee must be employed for the purpose of making sales and operate away from the employer's business location. Prior to August 23, 2004, FLSA also required that salespeople spend less than 20% of their time on non-sales work. New FLSA regulations eliminated this 20% threshold, as it was difficult to calculate and courts ignored it when making decisions regarding exempt status of salespeople. A bill before Congress also proposed to extend the exemption to inside sales staff as well. But the bill has not passed, as the line between salespersons and clerks would then be difficult to draw.

THE SALES JOB AND THE SALES EMPLOYEE

In most organizations the compensation program for sales personnel is different and separate from that of other employees. This different treatment has to do with the nature of the job, the importance of the job, and the nature of sales personnel. The dominant feature of sales compensation is the use of variable pay. Whereas variable pay plans are becoming more popular for a wide range of employee groups, the sales group has always been paid on a variable pay system due to the nature of the job.

The Sales Process

The sales process has a number of stages. These stages involve the sales person fully, peripherally, or not at all. These stages are:

  • Demand Creation. This stage is normally the function of the Marketing Department, however sometimes sales persons are involved in the process.
  • Buyer Identification. Sales persons are often very involved in this stage depending upon how their job is configured.
  • Purchase Commitment. This is the heart of the sales job, dealing with the customer and obtaining a commitment.
  • Order Fulfillment. This is the actual delivery of the product or service to the customer. Sales persons can be very involved with this or can be completely detached depending upon the job design.
  • Customer service. Like order fulfillment, sales persons may be very involved in this stage or totally uninvolved.

The importance of looking at these stages is twofold: to show that the sales job can vary greatly with the circumstances, and also that there are others that are involved with the sales process. It should be pointed out, however, that the main role of the sales person is persuading the customer to purchase the product or service; this is at the heart of sales compensation.1

The Customer

The nature of the sales job varies not only with where in the process the sales person operates, but also with the customers that they deal with. New vs. existing accounts is one distinction. Generally, developing new customers is a more difficult process than dealing with a group of customers with which the sales person is already familiar. If the customers are end users there is a higher probability of constantly having to be involved with developing new accounts. Selling to non-end users, such as distributors, requires less of a need to develop new accounts, but the sales person needs to support the intermediary in selling to the end user by doing training and promotional work.

Grouping customers by size is often done as there are clear differences in the needs of large and small customers. Frequently small customers get neglected when sales to large customers make the sales person more money. A company with many divisions and multiple products will tend to organize sales around product lines that often have very different characteristics from each other. Lastly, sales are often organized around either industries or geographical area, thus taking advantage of the knowledge the sales person can obtain in these specialized segments.

The Sales Job

Sales work involves working with customers to convince them to order the products or services of the organization. The importance of this activity is obvious. Except in the odd circumstance where the organization's product sells itself, this activity is vital to the continuing operation of the organization. Furthermore, this importance of the job is highly visible in the organization, making the impact of the job even clearer. But an in-depth analysis shows two things about sales work that should be kept in mind: not all of the salesperson's activities are sales work, and not all sales activity is carried out by staff labeled as sales personnel.

Sales Activity

Most sales jobs include activities such as soliciting orders, servicing customers, seeking out buyers, obtaining information, and performing cold calls and product promotion. Some sales personnel also engage in credit-information collection and analysis, product modification, customer-personnel training, and technical advice and assistance. All sales jobs require that the salesperson perform some administrative work, such as making reports and keeping records. Depending upon the market, the products, and the organization, various aspects of these activities are more or less important in particular sales jobs. Further, although some of these activities are important and necessary, they may not really be sales work, indicating that sales personnel do more than just sell.

This variety of sales activities suggests that it is necessary to develop job descriptions for sales jobs that clearly describe the contributions required of the employee. When the salesperson is paid on an incentive basis the non-selling activities can often be neglected unless they are clearly spelled out as a part of the job. These descriptions are most useful where there are a number of different types of sales positions in the organization. Sales job descriptions typically include not only information about activities, but also information about the number of customers, volume of sales, diversity of products sold, and geographical area covered.

Sales support

The typical mental picture of a salesperson is someone operating alone with the customer. For some positions this is an inaccurate depiction. Sales work requires the support of others in the organization. At one level there is administrative support enabling the salesperson to operate in the field. Some of this support is clerical. Another level in today's complex economic environment is support of the field sales effort by inside sales personnel. Many sales situations also require help in the form of technical expertise that is available from others in the organization. All of this support changes the picture of a salesperson. They are no longer seen as an independent operator and this has a considerable impact on developing incentive programs, which assume that it is the activity of the salesperson that brings in the sales orders.2

Characteristics of sales jobs

Despite these complexities, there are a number of dimensions of sales jobs that make establishing incentive programs useful and perhaps necessary. The first of these, importance of the function, has already been discussed. The others are independence, boundary spanning, and measurability.

Independence. As indicated, the typical picture of the salesperson is of someone working one-on-one with a customer outside the organization. For many sales positions this is still an accurate picture. Direct supervision and control of the salesperson in this circumstance is therefore very difficult. The traditional reliance on tools such as performance appraisal does not work as well since the supervisor does not see the salesperson in action. This makes reliance on the outcomes of the job more important. It should be noted, however, that the degree of independence of salespeople varies with the job situation. There is a great deal of difference between a salesperson that operates in a store where the supervisor is present, and one who is on the road.3 Where the employee is autonomous, control of behavior must be more internalized. One way of doing this is to reward the desired activities or the outcomes of the activities. In the case of sales personnel, rewarding sales volume keeps employees motivated. The problem is to have the salesperson achieve the outcome while doing so in an acceptable manner.

Boundary Spanning. The salesperson represents the organization to the customer. Often it is the salesperson that is the face of the organization to people outside the organization. This makes the sales position an important one for the organization's reputation. Likewise, the salesperson also represents the customer to the organization. This can create a situation within the organization of split loyalties, some to the organization and some to the customer.

Boundary spanners must be able to see both groups' point of view and to collect and transmit information between the groups. The salesperson is often seen as causing trouble for other employees inside the organization in order to serve the customer. Thus, the loyalty of the salesperson to the organization is likely to be perceived as less than that of other employees. This puts pressure on the compensation program, since it is compensation that is the major method of maintaining a positive membership decision.4

Measurability. This characteristic of sales jobs makes a variable pay program an attractive way to compensate salespeople. That the results of sales work are highly measured makes the incentive idea feasible. Sales volume, either in units or profits is easily measurable, and is connected with the efforts and ability of the salesperson. There is also considerable variation among salespeople in volume of sales – an important consideration in establishing an incentive program. Further, the salesperson expects to be rewarded by the use of an incentive program.

Using sales volume alone, though, can be a problem in rewarding salespeople. Connecting performance with reward focuses the person on the chosen performance factor to the exclusion of other job activities. If the organization wants results other than sales volume, it is not likely to get them if only sales volume is rewarded. Salespeople have a reputation for not doing their paperwork correctly or not doing certain things such as making cold calls or giving product presentations. These activities are not seen in the salesperson's eyes as clearly leading to more sales volume. Consequently most sales compensation programs need to reward more than just sales volume.

Last, there is the problem of connecting performance with effort. Sales jobs differ greatly in the degree to which the effort of the individual salesperson influences the measured output. If the sales effort is a group affair or the sale takes the efforts of other jobs in the organization, then using simple output measures may not be appropriate.

The Salesperson

Salespeople are often perceived as extroverts who can meet and deal with strangers and friends alike and get them to do what they want them to do. This, of course, is a stereotype. Like all stereotypes it has some truth to it, but overall it is too simplistic. Some sales positions do require the aggressive extrovert. But others require a high degree of technical skill and a great deal of patience to sell highly complex organizational outputs, one order of which may take years to complete. Studies do show, however, that successful salespeople are relatively aggressive, outgoing, self-motivated, and materially oriented.5 The sales job does seem to attract people with distinct characteristics: a tolerance for ambiguity and a high achievement drive.

Tolerance for Ambiguity The rewards of sales work, both extrinsic and intrinsic, are not constant or consistent, as they are in many other organizational jobs. Some days the salesperson comes home feeling that much has been accomplished, since in selling one can see positive results immediately. Other days there is no positive feedback: there have been no successful sales efforts, or other activities have prevented the salesperson from spending time on sales efforts. Thus, the salesperson experiences wide swings of positive and negative feedback. They must be able to adapt to this variation in reward structure. In fact this presence of uncertainty can act as stimuli to the salesperson.

The nature of sales work is ambiguous. The lack of performance feedback from the supervisor, the focus on outcomes and the consequent uncertainty of how to perform the job, as well as the lack of participation in decision making all lead to a lack of role clarity for the sales job. The salesperson can experience these closely defined parameters of their sales outcomes as a somewhat confusing when paired with the independent nature of their sales position. Added to this is the boundary-spanning aspect of the job, which creates role conflict as well as ambiguity.6

Achievement Drive. Psychologist D.C. McClelland has studied a number of socially derived needs of individuals.7 One of the most-studied of these is the drive to achieve. A person with a high achievement drive has a number of distinctive characteristics. The first of these is a desire to take moderate risks and to decide upon these for themselves. These risks are achievable but not easy to reach, and in this way provide a challenge rather than discouragement. The second characteristic is the need for immediate feedback. These people must be able to see that they are moving toward the goal. Third, the high achievers must find the path to the goal just as rewarding as the extrinsic reward at the conclusion of the activity. Last, high achievers are preoccupied with the task, focusing on the goal and keeping at it until it is achieved. If we put the last two together we can see why high achievers often feel a letdown upon reaching the goal: it was the pursuit and not just the realization of the finalized product that was stimulating.

These characteristics would seem to fit sales jobs and the compensation program typically developed for sales work. The sales job allows one to set one's own challenging goals, there is immediate feedback, and one can immerse oneself in the process of the sale and enjoy that process. In fact, McClelland found that the most likely place in the organization for high achievement drive to show up is in sales personnel. There appears to be a self-selection process whereby those with a high need for achievement find sales work to be most satisfying.

SALES COMPENSATION PLANS

As indicated, the dominant feature of sales compensation is the use of variable pay. The purpose is to align the objectives of the organization and those of the sales person. The objectives that may be used in sales compensation incentives include:

  1. Sales Volume. The amount of sales over a specified time period.
  2. New Business. Sales to new customers. This may require a great deal of cold calling.
  3. Retaining Sales. Keeping customers from one time period to another.
  4. Product Mix. The organization may wish to sell a pre-determined mix of products. This will help the competitiveness of the company by selling the whole product line.
  5. Win-back Sales. This is sales to old customers who are regained as clients.

Sales compensation plans can vary from ones that are based solely upon base pay to ones based solely on variable pay and those plans anywhere between these two points. We will consider the two extremes and then the middle position.

Straight Salary

Some organizations pay sales personnel a straight salary without any incentive. This makes setting wage rates for sales jobs similar to setting wage rates for other jobs in the organization. The positioning of the sales job can be arrived at through job evaluation and the appropriate salary range assigned to the sales job.

Sales pay ranges are affected by the same forces that influence other wages within the organization. The labor market is a major influence. Surveys of sales compensation are made by trade associations, consultants, and the organization itself. Variations in salary rates, however, tend to be larger for sales jobs than for other jobs. The ERI Salary Assessor software has wage survey data for over 150 different positions related to sales work in organizations. Salary relationships within the organization also influence sales wage rates. The sales-manager position and sales-support positions in the organization often are used as buffer positions; they can be compared with both the sales job and other organizational jobs.

Sales jobs are often more influenced by the incumbent than are other organizational jobs. The skills and abilities of the individual often dictate the particular activities that constitute a particular sales job.

Straight-salary plans do not preclude the use of performance-based pay. A performance-based pay program can be used to focus the salesperson on high performance levels. (See Chapter 14.) The sales job has the advantage of having a more measurable standard than other jobs, so the performance measurement is less judgmental. Keep in mind the dangers of sales volume alone being used as the measure of performance when other job factors may also contribute to the definition of performance.

Equity is always a problem in sales compensation. When sales personnel are paid a straight salary, the comparison with other organizational jobs through job evaluation reduces the equity problem within the organization. But it increases the equity problem with other sales jobs that are paid on an incentive basis. It is difficult to compare sales positions paid on a commission and straight salary, for they often involve quite different work.

There are a number of circumstances that make straight salary plans advantageous. These all center on the inability to connect either performance to reward or effort to performance. Where the product is highly complex, the time taken to culminate a sale is long, and/or the sales effort is a team affair, a variable pay plan is infeasible. In some sales jobs the non-sales aspects are of primary importance to the organization, and the results of these activities are difficult to measure. In general, the less impact the salesperson has upon the sales results, the less argument there is to establish a variable pay program. Also, a variable pay program may be unfair to new salespeople, who do not know the job or the customers well enough to meet sales goals.

Advantages of straight salary plans. A straight-salary program has certain advantages to the organization, the salesperson, and the customer. From the salesperson's standpoint, a straight salary takes the ambiguity out of how much salary he or she is receiving. Some people are very uncomfortable not knowing how much they will make next month, or are unable to budget the good times to cover the bad times. For the organization, a straight salary plan is much simpler. In addition, it gives the organization more control over the salesperson. One of the aspects of placing a person on incentives is that the person feels much more independent of organizational control. It has also been found that salespeople under a straight salary plan are more willing to perform the non-sales aspects of the sales job.8 From the standpoint of the customer, the sales person on a straight salary is more likely to provide service and less likely to pressure the person into a sale and move on.

Disadvantages of straight salary plans. The disadvantages of a straight-salary program reverse the advantages above. They are centered in the lack of connection between performance and reward and therefore suggest that motivation levels among salespeople paid in this manner can be expected to be lower than those of salespeople on incentives.

From the organizational viewpoint, straight salaries are a fixed cost rather than a variable cost, making sales salaries a burden in times of low sales. Furthermore, poor performance must be dealt with administratively, a requirement that is becoming more difficult each year.

Commission Plans

A straight commission plan is like a straight piecework plan in that the salesperson's earnings are in direct proportion to their sales. It is probably the oldest form of compensation program for sales personnel.

In theory, a commission plan is very simple. A commission is ordinarily defined as a percentage of the sales price of the product.9 The exact percentage is highly variable with the product being sold, the industry practice, and the organization's economic situation. It also varies with internal organizational factors and the exact nature of the sales job. For instance, the directness of the relationship between the salesperson's efforts and the sales volume usually affects the percentage given to the salesperson. Two things need to be noted about providing a percentage of the sale to the salesperson. First, the percentage need not be the same at all levels of sales; it may increase or decrease with volume. This increase or decrease can be related to the effort the salesperson must exert to increase the sale's volume. The second point is that sales may be stated as sales price, sales units, or some other measure that reflects the variation in sales. In particular, the point in the sale process where the sale is counted is important. Sales percentages calculated at the point of sale versus the point of delivery are different figures and occur at different times for the salesperson.

The effects of the commission system need to be examined before it is put into operation. The basic calculation that needs to be made is an estimate of what amounts will be paid to sales personnel in the form of commissions. This information should be used in a number of ways. First, it should be used in the pay level sense of determining the total cost of selling the product. Here the concern is whether sales costs are in line with other costs of production. Second, estimates of commissions should be used in a wage structure sense of determining whether wages paid to salespeople are in line with wages paid other jobs in the organization and with those paid sales jobs in other organizations. Third, these estimates should be used to determine the expected income to the sales personnel. A variable pay program may look like a good plan, but unless a sufficient percentage of the sales force are likely to make a minimum amount over expectations, the incentive value of the program may be negative.10

Performance motivation. The performance-motivation model specifies that for a variable pay plan to be effective the following conditions must be met:

  1. Employees must believe that good performance leads to more pay. A commission plan should clearly do this by its construction. This belief is strengthened when the measurement of results is clear and objective. If there is a long time between point of sale and delivery or if many sales are not converted to delivery, this relationship can be weakened.
  2. Employees must desire more pay. This seems obvious, but it is more complex than that. First, people differ in their desire for more pay, although sales personnel are reputed to be a group that strongly desires pay.11 Second, the increased pay must be worth the effort: if more sales, and therefore more pay, mean more overtime, some people will choose not to pursue more pay. Organizations may be safe in assuming that through self-selection, those who enter sales work highly desire pay, but as sales jobs become more complex and technical this assumption may become less valid.
  3. Employees must believe that good performance will not lead to negative consequences. Unfortunately, this is a likely consequence of commission plans. Sales incentive plans are often changed by the organization. These frequent changes are perceived as ways to solve two opposite problems – lack of sales and perceived overpayment of sales personnel. From the salesperson's viewpoint these changes create confusion in the performance-reward connection and a feeling that the organization is cutting the rate. Further, many sales incentive plans are so complex that the salesperson becomes confused as to what will happen if he or she takes certain actions. So some actions are avoided because the salesperson does not know what the consequences of taking action will be. Last, the sales incentive plan can put the salesperson in conflict with the rest of the organization. Difficulties between sales personnel and credit, finance, manufacturing, and shipping are everyday events in many organizations.
  4. Employees must see that desired rewards besides pay result from good performance. Sales incentive plans are mixed on this. Feelings of achievement, esteem, and respect are quite likely to occur along with high incentive pay for most sales personnel. On the other hand, high pay restricts long-term movement within the organization. Sales positions are often perceived as having little career-growth opportunity.12
  5. Employees must believe that their efforts lead to good performance. This perception varies widely among sales incentive plans. Where certain activities clearly lead to sales then this perception is strengthened. However, there are a number of hindrances to this connection. Since sales are highly affected by the economy, the product, past relationships, and other factors beyond the salesperson's control, the connection is often tenuous. The sales incentive plan itself may be perceived as not rewarding important efforts of the salesperson or rewarding efforts that are of little importance. The problem is that if the plan includes a wide range of relevant efforts, then it becomes so complex that the performance-reward connection is simply not clear and losses its impetus.

Combination Plans

A majority of sales compensation plans are some sort of combination of base pay and variable pay. The reasons given for developing combination plans are that (1) the salesperson is not the only influence on the sales volume, and (2) some parts of the sales job do not involve direct selling and these also need to be rewarded. Done properly, a combination plan should contain the advantages of both straight-salary and commission plans. On the other hand, such plans can also be seen as management indecision as to what they want of salespeople, and they can confuse the salesperson as to what is important in the job.

Sales Standards. All combination plans involve the establishment of a sales standard – for instance, the expected volume of sales for a particular time period. In the sales field this standard is usually called a sales quota. But the standard may be broader than just sales volume: other factors, such as obtaining new customers, retaining customers over time, and doing prospecting work, can be included. The advantage of including a number of variables in the standard is that the plan then more clearly covers the whole sales job. The disadvantage is that the complexity of the plan is increased and the salesperson may become confused about what he or she is being paid for.

The basis for developing the standard is the level of sales and other factors that the salesperson can be expected to achieve. Establishing this standard is more difficult here than it is in most incentive plans in a number of ways. Sales jobs tend to be individual, in terms of both the salesperson and the customers dealt with. Also, outside influences can easily affect the sales volume. In setting sales quotas it is useful to consider the past year's performance, economic conditions, technological changes, and competitors' strategies. For these reasons setting the expected volume is more often a figure negotiated with the individual salesperson than a standard for all salespeople to meet.

The standard generally sets the level at which the salesperson's straight salary is considered covered by the sales volume. But this can vary. Another option is to have the incentive start after some percentage of the standard has been reached. Straight salary usually constitutes around 75 percent of the total salary in combination plans, but this percentage can be planned as high or as low as desired. The incentive portion will be lower where the direct contribution of the salesperson to sales volume is low, where non-sales activities are valued by management, and where there are considerable variations in sales over time and between sales areas.

Payment Structure. There are a number of ways of establishing the incentive portion of sales compensation. Probably the simplest system is to use a commission combined with a draw. The salesperson receives a specified salary each payday. At periodic times, such as each quarter, the total commissions due the salesperson are calculated. The amount taken as a draw is deducted from this and the salesperson then receives the remainder. If the draw exceeds the commission, the organization must decide whether to reduce the draw, carry over the deficit, and/or retain the salesperson in the position.

A bonus system provides incentive payments after a given level of sales has been reached. These plans can be quite simple or very complex. Simple ones resemble a commission-draw system with a percentage payment made for sales above a standard. More complex plans have payment schedules that vary with sales volume or that give payments for a variety of things beyond sales volume, such as obtaining new accounts, reducing sales expenses, improving market penetration, and increasing order size. A variation on the more complex bonus plans is the point plan. Here the salesperson receives points for meeting and exceeding goals or quotas in a number of areas. These points are then converted to monetary values.13

Completing the Sales Compensation Package

Sales compensation considerations do not end with the design of the direct pay system. There are other aspects of sales compensation that are unique, including the use of contests and benefits.

Contests. The measurable-output of sales jobs allows the organization to design a short-term reward system that gives prizes for accomplishing certain quotas or selling more than all others. This is often attractive to the type of person who enjoys sales work. The prizes can be either monetary or non-monetary but more often are not direct pay. Most popular are non-monetary prizes such as vacation trips or goods such as golf clubs or other recreational equipment.

These contests have a number of advantages. First, they provide a very visible reward. Records of who-won-what can be placed on bulletin boards and put in the company newsletter. It is interesting that this publicity seems natural for a contest but out of place for direct pay. Second, a contest, like any bonus, is a one-shot affair: it does not add to the overall wage costs beyond those of the contest. This allows the rewards to be large and still not have a detrimental effect on labor costs. Last, contests extend to the salesperson's family more clearly than direct pay. Such awards as vacations are shared with family members, ideally creating company loyalty within the family as well as the salesperson.

Contests also have some disadvantages. The publicity can be very discouraging to those salespeople who perceive they have no chance to accomplish the level of sales necessary to win an award. Not only are they not receiving a reward but all their colleagues are aware of their shortfall. This is particularly hard on new sales personnel or those in difficult territories. Contests may also shift the focus from the main job to side issues. If the awards are for selling items that are not important to the overall sales effort, then the total sales of the company may actually decline as a result of the contest.14

Benefits. Salespeople used to be perceived almost as independent contractors. As such they were not included in benefit programs to the same extent as other employee groups. This situation has changed, and sales personnel are now recipients of regular organizational benefit programs and at times, more. This inclusion in benefits programs should have the effect of increasing the commitment of the salesperson to the organization. Sales personnel are usually granted two benefits that are not common to other employees: expense accounts and travel allowances.

EXPENSE ALLOWANCES

Many employees are required to travel as a part of their job. But sales people, more than any other group in the organization, travel. Some of this travel is around town from one location to another during the day. Other travel requires the sales person to be "on the road" for some period of extended time away from home. At a minimum these employees may deduct expenses derived from their travel as an expense from their income tax. However, most organizations reimburse the employee for these expenses. Properly done this then becomes a deductible expense for the organization and the payments to the employees are not classified as income to the employee.

Accountable Plans. The following are the three requirements for an accountable plan:

  1. There must be a business connection and the expense must be reasonable.
  2. There must be reasonable accounting for the expenses.
  3. All excess reimbursements must be repaid in a reasonable time.

The deductibility of business expense reimbursements depends chiefly on whether the payment is made under an accountable plan. There is a definite advantage to seeing that reimbursements are under an accountable plan from a tax perspective for both the organization and the employee. An accountable plan is a reimbursement arrangement that meets the following three requirements:

  1. The reimbursements must be for the organization's deductible business expenses that are paid or incurred by an employee in the course of performing services for the organization. A reimbursement arrangement will fail this requirement if the employer does not reasonably believe that the employee will use the reimbursement to pay for deductible expenses.
  2. The employee must be required to substantiate the amount, time, use, and business purpose of the reimbursed expenses to the organization. In order to do this, the employee should submit an account book, diary, log, statement of expense, trip sheet, or similar record, supporting each of these elements and making sure that it is recorded at or near the time of the expenditure. The records should include any supporting documentary evidence, such as receipts. As will be seen later, an employee who receives a mileage allowance is considered to have substantiated the amount of the expenses if the employee substantiates the time, place (or use), and business purpose of the travel. More important the establishment of a FAVR plan meets this substantiation requirement as will be discussed below.
  3. The employee must be required to return any excess of reimbursements over substantiated expenses within a reasonable period of time. This needs to be set forth in a written plan. The IRS will generally accept the organization's plan if the employee is required to provide substantiation within 60 days or return unsubstantiated amounts within 120 days after an expense is paid or incurred. If the organization furnishes employees with periodic statements (not less frequently than quarterly) of unsubstantiated expenses, amounts substantiated or returned within 120 days of the statement will be considered returned or substantiated within a reasonable time. The written plan must be followed: employees must in fact return unsubstantiated allowances.

If the organization's plan does not meet these requirements and you have a non-accountable plan what is the cost? To the organization the cost is in having to pay FICA taxes on the reimbursement amounts paid to employees. To employees the cost is having the reimbursements considered wages and then having to deduct them from their own tax returns. For further information go to www.irs.gov.

There are two main types of travel allowances — automobile allowances and per diems.

AUTOMOBILE ALLOWANCE REIMBURSEMENT PLANS

There are three basic types of reimbursement plans for accounting for automobile expenses. These will be described here and examined for their advantages and disadvantages.

Actual Expense Method. In this method the employee is required to keep track of all expenditures in regard to their automobile and to report them periodically to their employer for reimbursement. This would include all the items mentioned in 2 above under accountable plans. The items can include both fixed [registration fees] and variable items [gasoline and oil]. The total costs would then have to be divided by the percentage of total usage of the automobile for business vs. pleasure.

The advantage to this method is that it reflects the actual costs, as opposed to estimated costs, and can be a complete accounting of all costs. The disadvantage of the method is that it is time consuming and arduous to keep such a complete record of expenses. Since it is the employee keeping these records there can also be a tendency to inflate the figures.

Standard Mileage Method. The simplest and most common way to reimburse employees for their automobile expenses is to pay them a mileage allowance, based on the number of business-related miles they drive.

Ordinarily, the employer will use the Standard Mileage Rate that's set by the federal government each year. However, the organization may pay employees a higher rate so long as the rate is reasonably designed not to exceed the employee's actual or anticipated expenses. In this case the amount of expense the organization can deduct is the lesser of:

  • the amount the organization paid under its own mileage allowance
  • the government's standard mileage rate multiplied by the number of business miles substantiated by the employee

If the organization uses the standard mileage allowance method, the employees won't have to keep track of their total actual car expenses but do need to keep written mileage records that show the time, place, use, and business purpose for each car trip.

The standard mileage rate is reviewed and changed each year by the federal government. This information is available at www.irs.gov.

The main advantage to using the standard mileage method is clearly simplicity. The record keeping is limited. Further simplification is provided in that the mileage rate is not subject to dollar caps or the special rules that apply if qualified business use does not exceed 50% of total use. The major disadvantage to the standard mileage method is that it may not cover the full costs of driving the automobile, particularly when fixed costs such as depreciation are taken into account. The employee, however, may be able to calculate these further costs and deduct them as expenses from their taxes.

Fixed and Variable Automobile Rate Allowance [FAVR]. This type of plan was approved by the IRS initially in 1992 but has never become a popular alternative method for paying automobile allowances. The regulations can be found in Revenue Procedure 200-49. [note that these procedures are revised about every two years so you may need to go to www.irs.gov and search for FAVR.] This type of plan develops estimates or stated schedule of both fixed and variable automobile expenses, that when tied to a "standard" automobile and the number of miles driven for work related activities, provides a basis for substantiating the reimbursements.

The reimbursement provided by the organization that is computed using a FAVR plan is in lieu of the employee's deduction of all the operating and fixed costs paid or incurred by an employee in driving the automobile in connection with the performance of their services as an employee of the organization. Items such as depreciation (or lease payments), maintenance and repairs, tires, gasoline (including all taxes thereon), oil, insurance, license and registration fees, and personal property taxes are included in operating and fixed costs for this purpose.

The advantage of FAVR is that it provides complete reimbursement for all automobile expenses while keeping the record keeping of the salesperson to a minimum. The major disadvantage is that the organization has to do a lot of work to set up and administer the "standard" automobile construct. A more complete description of FAVR can be found in ERI distance Learning Center course #38.

Company Vehicles

An alternative to reimbursing employees for the use of their vehicles is to provide a vehicle for their business use. If the vehicle is used entirely for business purposes there are no consequences for the employee and the employer may deduct the costs of the vehicle as a business expense.

When the vehicle is also used by the employee for personal purposes the situation becomes more complex. The personal use becomes a benefit to the employee and is considered income and therefore taxable. For this purpose the employee must maintain a log of all travel in the vehicle and whether it is business or personal.

In order to determine what value to place upon the personal use of the vehicle there are two methods that are considered "safe harbors" by the IRS.

  1. Lease Value Rule. The employer must determine the fair market value of the vehicle, the annual lease value in this case. The IRS makes this easy by providing an annual lease value for vehicles based upon the vehicle's fair market value. This in turn can be obtained from a number of sources such as the Kelley Blue book or the manufacturer's invoice price plus 4%. The annual value is then multiplied by the percentage of use that was personal for the year to determine the benefit received.
  2. Cents-Per-Mile Rule. In this method the employer values the benefit by multiplying the employee's personal miles by the current standard mileage rate. If the employee pays for the gas up to 5.5 cents can be deducted from the rate. In both of these cases there is a limitation on the value of the vehicle that can be used to determine the benefit. This value changes with time so it needs to be checked with the IRS.

Per Diems

A per diem allowance is a fixed amount of daily reimbursement the employer pays the employee for lodging, meals, and incidental expenses. Federal government per diem rates can be figured by using one of the following methods:

  1. The regular federal per diem rate. This rate varies with location. It includes all the lodging, meals and incidental expenses. These per diem rates can be found online at: www.gsa.gov
  2. The standard meal allowance. This alternative is used when the employee does not have any lodging expense, such as when the employee stays in a company room or with relatives. It covers only meals and incidental expenses. The above sources also have calculations for this category of expenses.
  3. The high-low rate. This is a simplified computation with one rate for high cost cities and another for regular locations. The amount changes each year. In October 2017 it paid $191 a day in most cities for lodging and meals, while it paid $284 for high cost cities. The current amounts and cities may be found n IRS Notice 2017-54. See www.irs.gov

Where an expense allowance arrangement has no mechanism or process to track allowances paid and routinely pays per diem allowances in excess of the federal per diem rates without requiring actual substantiation of all the expenses or repayment of the excess amount, all payments made under the arrangement will be treated as made under a non-accountable plan.

SUMMARY

Organizations identify certain groups in order to establish special compensation programs for them. They do this for a number of reasons including organizational tradition, employee expectations, importance and centrality of the job, and the law. This chapter discusses one such group – outside salespeople.

Salespeople are paid primarily using a variable pay plan. There are a number of reasons for this, not the least of which is organizational tradition. Sales jobs tend to be central to the organization, are carried out away from direct supervision, have measurable outcomes, require the person to be a boundary-spanner, and attract people who like incentive programs.

Sales compensation plans may be straight salary, straight commission, or a combination of these two. The latter is the most common. Since sales plans are ordinarily individual plans, there is an assumption that it is the sales person's efforts that makes the difference. This assumption is called into question more often as selling becomes more of a team effort. Sales compensation plans also may include competitive contests and special benefits.

A second part of sales compensation is the reimbursement for business expenses. Development of a program in this area is tied closely to the demands of the IRS so that reimbursement (from an approved expense) is not in fact income. The most common program for reimbursements is one that pays for both per diem and automobile expenses tied to federally defined rates.

Footnotes

1 Cichelli, D. Compensating the Sales force, New York, McGraw-Hill, 2004.

2 Colletti, J. & Fiss, M., Compensating New Sales Roles 2nd Ed., New York, American Management Association,2001

3 R. B. Marks, Personal Selling (Boston: Allyn & Bacon, 1985).

4 Goolsby, J. "A Theory of Stress in Boundary Spanning Positions of Marketing Organizations" Journal of Academy of Marketing Science, Vol 20 #2 1992

5 L. M. Lamont and W. J. Lundstrom, "Identifying Successful Salesmen by Personality and Personal Characteristics," Journal of Marketing Research, 16:1977, p. 525.

6 Goolsby, J. Op Cit

7 D. C. McClelland, The Achieving Society (New York: Free Press, 1961).

8 G. Canning, Jr., and R. Berry, "Linking Sales Compensation to the Product Life Cycle," Management Review, July 1982, pp. 43-46.

9 Cichelli, D. Compensating the Sales force

10 B. Ellig, "Sales Compensation: A Systematic Approach," in Compensation and Benefits: Design and Analysis, ed. B. Ellig (Scottsdale, Ariz.: American Compensation Assn., 1985), pp. 36-45.

11 D. L. Thompson, "Stereotype of the Salesman," Harvard Business Review, January-February 1972, pp. 20-36.

12 Colt, S. The Sales Compensation handbook, 2nd Ed. New York, American Management Association, 1998.

13 Cichelli, D. Compensating the Sales force

14 T. R. Wotruba and D. J. Schoel, "Evaluation of Salesforce Contest Performance," Journal of Personal Selling and Sales Management, May 1983, pp. 1-10; and D. Hampton, "Contests Have Side Effects, Too," California Management Review, Summer 1970, pp. 86-94.

Internet Based Benefits & Compensation Administration

Thomas J. Atchison
David W. Belcher
David J. Thomsen

ERI Economic Research Institute

Copyright © 2000 - 2013

Library of Congress Cataloging-in-Publication Data

HF5549.5.C67B45 1987 658.3'2 86-25494 ISBN 0-13-154790-9

Previously published under the title of Wage and Salary Administration.

The framework for this text was originally copyrighted in 1987, 1974, 1962, and 1955 by Prentice-Hall, Inc. All rights were acquired by ERI in 2000 via reverted rights from the Belcher Scholarship Foundation and Thomas Atchison.

All rights reserved. No part of this text may be reproduced for sale, in any form or by any means, without permission in writing from ERI Economic Research Institute. Students may download and print chapters, graphs, and case studies from this text via an Internet browser for their personal use.

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