What is Gross-Up?
A gross-up is an amount of money that an employer adds to a payment to cover income taxes their employee will owe for that payment. This additional gross income helps relieve the employee of the tax liability associated with relocation expenses. For example, if relocation costs include $5,000.00 taxable dollars, the employer may pay a total of $7,500.00 so that the employee receives the full benefit of the $5,000.00, with the estimated taxes of $2,500.00 paid by the employer.
How Does Gross-Up Work?
Taxes are inevitable in any employer-employee relationship. Federal and state governments require employers to withhold taxes from the employee’s paycheck. Nearly all corporate transactions are taxed, including relocation package benefits provided to employees. Most relocation expenses associated with a move, whether reimbursements made to an employee or payments made vendors on the employee’s behalf, must be reported as taxable income to the employee and are subject to IRS supplemental withholding regulations. Employers sometimes choose to ‘gross up’ an employee’s income to cover the additional taxes incurred due to these taxable benefits in income tax calculations.”
When To Use Gross-Up
Offering tax assistance (gross-up) may be a gesture of goodwill towards the relocating employee. Unfortunately, grossing up expenses can add 55% or more to taxable relocation costs. However, considering the benefit to employees’ long-term satisfaction and retention, many employers view gross-up costs as money well spent.
How to Calculate Gross-Up: 3 Tax Gross-Up Formulas & Examples
Formula #1 – The Flat Method
The flat method uses a flat percentage calculated on the taxable expenses and then added to the income. For example, an employer may gross-up at a rate of 25% for taxable expenses. If the employee is owed $1,000, the gross-up would be 25% of this, or $250. Therefore, the employee would receive a total benefit of $1,250.
Importantly, this method likely will not fully cover the employee’s tax liability since the gross-up itself qualifies as taxable income. Additionally, this tax gross-up formula does not comply with supplemental withholding regulations.
The following tool will help you calculate tax gross-up using the flat method:
Formula #2 – The Supplemental/Inverse Method
Employers often use this gross-up formula to compensate for the additional tax liability created by the gross-up amount. With this method, employers pay a gross-up on the gross-up. To determine the amount, add up all the tax rates (fed, state, OASDI, SS) and then divide the total taxable expense by the sum of the tax rates. Then take the result and subtract the taxable expense.
Note that while this method covers gross-up on the gross-up, it may not accurately reflect the tax bracket of the employee.
The following tool will help you calculate tax gross-up using the supplemental/inverse method:
Formula #3 – The Marginal/Inverse Method
Typically, a CPA or full-service relocation companies will use this method which also incorporates a tax on tax calculation. The difference with the marginal/inverse method is that it takes into account employee income and IRS Form 1040 tax filing status. In most cases policy dictates that only company-earned income may be considered. The calculation does not include other forms of income, such as spousal income or investment income.
These three tax gross-up formulas represent the primary methods for grossing up taxable relocation expenses to assist with an employee’s tax liability. While some companies may choose to perform these calculations in-house, we recommend seeking guidance from experienced relocation experts.
3 Steps for Calculating Tax Gross-up
- Decide on which formula you want to use: The Flat Method, The Supplemental/Inverse Method, or The Marginal/Inverse Method.
- Review common relocation tax mistakes to avoid any critical errors.
- Determine whether your company should handle relocation tax in-house or work with a trusted advisor.
For help eliminating tax errors and omissions, partner with an experienced global mobility management company that will track employee expenses, submit accurate reports of taxable costs, and calculate tax gross-up. The formula for gross up calculation typically involves accounting for the tax rate applicable to the reimbursed amount and adjusting the employee’s income accordingly to cover the additional tax liabilities.”
Mishandling Tax Gross-up
When handled properly, a tax gross-up can reduce the tax burden on an employee and provide consistent records to better prepare both the employee and employer for tax filing. However, if calculated incorrectly, a relocation tax gross-up can result in the following issues:
- Extra work, time (i.e., increased expense), and frustration for your accounting and HR departments to review their records, recalculate and correct mistakes, and potentially issue W-2C forms.
- Diminished employee morale due to additional taxation, resulting in reduced productivity and retention rates.
- Filing delays and/or employee extension requests, potentially resulting in penalties.
- Amended tax return filing as a result of incorrect W-2 statements.
- Audit and/or tax penalties and other fines for the employee as well as the company.
The IRS discusses the tax consequences of moving expenses, including the gross-up concept, in Publication 521 “Moving Expenses” and Publication 523 “Selling Your Home.” We recommend both publications for employees planning a job-related relocation.
Should Your Company Handle Relocation Tax Itself Or Give The Job To A Pro?
Many corporate accounting and finance departments, while adept at handling day-to-day corporate financial operations and record-keeping, may not have the expertise when it comes to accurately and fairly figuring tax gross-up. Due to the complexity of tax laws and other local, state and federal regulations, turning the work over to a full-service global mobility management company may be beneficial. To learn more about how CapRelo can help, contact us today.
Tax Gross-Up: Key Takeaways
Working with an experienced global mobility management company that can efficiently handle all aspects of a relocation may prove beneficial in eliminating tax errors and omissions. A global mobility management services provider will track expenses and submit accurate reports of taxable costs as well as help calculate tax gross-up. As one of your preferred suppliers, a trusted global mobility management company can offer you and your employees peace of mind – along with a lower tax bill.