Accounting for Referral Fees

Advice on how to figure "thank you" payments for referrals, and how to enter them into your bookkeeping system. March 25, 2008

I own a hardwood flooring company. Recently, we have been getting a lot of business from renovation contractors. I would like to say "thank you" by sending them a referral fee of 10% of the final invoice amount. Some of them expect that, however those expectations are rarely indicated in the initial conversation. How would I handle such “business expense” from the accounting and bookkeeping perspective? Do I calculate the 10% of the total net price of the job, or do I use the gross amount? Will I subtract the 10% from the final invoice amount and use it as a business expense and write it off when submitting my input tax credits? When handing someone a check for the 10%, do I also give them a statement specifying the referral job information, and do I add the tax to the referral amount that I pay them, and expect them to file it as income? How is this done in real life situations?

Forum Responses
(Business and Management Forum)
From contributor B:
I group this expense in with the advertising. I don't know what the standard is for flooring, but 10% of gross seems very high. I will typically give 3% of gross to a designer that refers me a good job (cabinetry, not flooring). I came up with this number because that is what it would cost me to advertise and get the same amount of work. From a tax perspective, I would think it would be best to ask your accountant.

From contributor J:
Whatever you do, don't write a check to an individual unless you are prepared to file 1099s if the amount is enough. Not sure what you mean by " I add the tax...?" Sales tax? No, you didn't purchase anything from them. I wouldn't debit the advertising expense account because it's not advertising and it would be confused with your real advertising expense.

From contributor E:
I show this expense as outside sales. I pay their company, not the individual. If it is the person - I do the 1099.

Form the original questioner:
Thank you. It helps a lot to know what others are doing in similar situations. We are in Ontario, Canada, so I have no idea what a 1099 is ;) I will definitely talk to my accountant. I don't want any issues with CCRA (our version of your IRS).

From contributor S:
Whatever commission you pay for the referral, make it a percentage of the total sale, not the net. You do not want to divulge your profit margins. Doing so will leave you open to a lot of penny pinching in the future. Do not pay a percentage of the sales tax. For accounting purposes, it goes in the same column as "bribes, kick backs, commissions or salesman expense."