Tax gross up can add considerable costs to corporate relocation packages. Tax gross up can increase taxable relocation costs by 45% to 55%or more.
What is tax gross up, in a nutshell, and why does it cost your company money? Tax gross up occurs when you add to the taxable reimbursement amount so that relocating employees don't face a tax liability after receiving one-time relocation incentives or reimbursement of their taxable relocation costs. It's standard practice to offer tax gross up, as it adds to employee satisfaction, makes a move easier on relocating employees, and can provide added incentive for employees on the fence to make the decision to relocate.
Calculating Tax Gross Up
You can calculate tax gross up in three ways.
A flat percentage calculated on taxable expenses and added to income. While this method may be the easiest for the company, it is not compliant with IRS regulations, and it is likely the employee will be liable for additional taxes on the added flat gross-up percentage because this is also considered a taxable benefit.
Although perceived as a bit more complex than the flat method, this method incorporates the tax-on-tax calculation, which is IRS compliant and gives the employee the added tax assistance on the gross-up that the IRS considers a taxable benefit. Some companies choose to use the IRS supplemental rate (currently 25%) for all employees regardless of income level.
This method is typically handled by a CPA or full-service relocation companies and also incorporates the tax-on-tax calculation. The difference is that the marginal methodology takes into account employee income and IRS Form 1040 tax filing status. In most cases policy dictates that only company-earned income will be considered and other forms of income, such as spousal income or investment income, won't be taken into account.
Inverse Example: Transferee is paid $1,000 and has a total tax rate of 34% (federal, state, OASDI, Medicare). The gross-up amount is determined by taking 1 minus the tax rate and dividing the taxable expenses by that amount.
1 - .35 = .65
1000 / .65 = $1,538.46 (total benefit to the employee)
$1,538.46 (total benefit) - $1,000 (taxable expense) = $538.46 inverse gross-up amount
While tax gross up adds to your corporate relocation costs, it results in a more fair corporate relocation package, happier employees and better retention rates.