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What Is Gross-Up?
A gross-up is an amount paid by an employer on the behalf of an employee to offset the costs of the employee’s taxes, such as additional taxes and/or relocation fees. These types of payments are optional.
Why Are Gross-Ups Important?
Typically used as a one-time offer, gross-ups are important for a number of reasons. For example, increased employee satisfaction and decreased tax liability for employees.
- Employee satisfaction. Employee satisfaction is an indicator of how content your employees are with their jobs, their employee experiences and your organizations. A gross-up can boost employee satisfaction by helping keep the employee’s tax liability low.
- Tax liability. A gross-up shifts much of the tax liability incurred to the employer rather than the employee. For example, an employer may gross-up the relocation assistance amount to persuade a candidate to relocate. The relocation benefits offered would offset the additional taxes due by the new employee.
Examples of Gross-Up
Contingent upon your organization’s goal, there are three ways that an organization can use a gross-up: the flat-method, the supplemental inverse method or the marginal inverse method.
Example 1: Flat-Method
When using this method, a flat percentage is calculated on the taxable expenses and then added to the employee’s income. This type of gross-up qualifies as taxable income and may not fully cover the employee’s tax liability.
Example 2: Supplemental-Inverse Method
This method is used when organizations would like to compensate for the additional tax liability created by the gross-up. Basically, a gross-up is paid on the gross-up. It is the most common method used.
Example 3: Marginal-Inverse Method
This method is most commonly used by a certified public accountant (CPA) or an organization that specializes in relocations. This method utilizes the employee’s income and IRS Form 1040 tax filing status. Other forms of income are not included in this method.
How to Calculate Gross-Up
When paying supplemental compensation, such as a bonus or a relocation payment, payroll taxes must be paid. The formula used to calculate a gross-up is: Gross pay = net pay / (1 – tax rate).
Below are four basic steps employers should take when grossing up salaries.
Step 1: Calculate the Tax Rate
An employer can begin by calculating the employee’s federal, state, and local tax rates.
Step 2: Calculate the Net Percentage
Next, you’ll need to subtract your total tax rate from one (1). This amount is your net percentage.
Step 3: Calculate the Gross Payment
After you’ve calculated the net percentage, divide the net payment by the net percent. This amount is your gross payment and represents the gross amount needed to provide the employee the amount promised as a net salary.
Step 4: Verify Your Calculations
After completing steps one through three, verify your calculations by calculating gross payment to net payment.
When to Offer Employees Gross-Up
There are a number of reasons why an organization may gross-up an employee’s salary. These can include bonuses, relocation, and benefits.
Bonuses are additional funds/wages provided to an employee who has met a certain criteria, whether through their own actions or collectively with others.
Bonuses are typically a one-time payment of a certain amount. Grossing up the bonus ensures that the employee receives the amount promised after taxes.
Prior to the Tax Cuts and Jobs Act of 2017, relocation benefits were not considered taxable income for employees. As a result of the act, employees are now taxed on benefits they receive as part of relocating. To ensure a smooth transition, many organizations provide a relocation package and gross-up the employee’s salary to offset the cost of taxes incurred.
With some exceptions, fringe benefits such as the use of a company vehicle, aircraft, or memberships are generally included in an employee’s gross income, and are subject to income tax withholding and employment taxes.
Questions You’ve Asked Us About Gross-Up
Wendy is a HR professional with over 10 years of HR experience in education and health care, both in the private and non-profit sector. She is the owner of KHRServices, a full service HR management agency. She is also SHRM and HRCI certified, serves as a HRCI Ambassador, and voted 2021 Most Inclusive HR Influencer.