What is Gross-Up?
A gross-up is when the employer offers an employee the gross amount that will be owed in taxes. This additional gross income helps to relieve the employee of the tax liability associated with relocation expenses. For example, if the relocation costs include $5,000.00 taxable dollars, the employer may pay a total of $7,500.00 so that the employee gets the full benefit of the $5,000.00, as the estimated taxes of $2,500.00 are paid by the employer.
It's said that death and taxes are the only certainties in life. I'll leave the answer to that question to the great philosophers. However, one thing is an absolute certainty: taxes are a fact of life.
This is particularly true in the employer, employee relationship. The government requires that the employer withhold taxes from the employee's paycheck. Some would call this wise on the government's part, others wouldn't be so kind. In the corporate world, practically everything is taxed, including aspects of relocation packages provided to employees. Most relocation expenses associated with a move, whether it is a reimbursement made to a transferee or a payment made to a vendor on the transferee’s behalf, is required to be reported as taxable income to the employee and is subject to IRS supplemental withholding regulations.
Can you imagine the look on your employee's face when you gently explain that the generous relocation bonus provided will increase his or her tax burden? It is a guarantee, the once happy employee's mood will change quickly and not for the better. Well, fortunately for these employees, a portion of the tax liability of the relocation package can be covered by tax assistance (gross-up) paid by the employer. Unfortunately, grossing up can add 55% or more to taxable relocation costs. If you consider the obvious benefit to the employees’ long-term happiness, it is money well spent.
3 Tax Gross-Up Formulas You Can Use
Gross-Up Formula #1 - The Flat Method
The flat method is a flat percentage calculated on the taxable expenses and then added to the income. For example, an employer will gross-up at a rate of 25% for taxable expenses. If the transferee is paid $1,000, the gross-up would be 25% of this, or $250, and therefore the transferee would receive a benefit of $1,250 total. Note that the gross-up is also considered taxable income and may create an additional tax liability to the transferee.
It’s important to note that this method likely doesn't cover the employee's tax liability since the gross-up is taxable income. Additionally, this tax gross-up formula is not compliant with supplemental withholding regulations.
The following tool will help you calculate tax gross-up using the flat method:
Gross-Up Formula #2 - The Supplemental/Inverse Method
This gross-up formula is often used because not only are relocation expenses considered income, but the gross-up is considered income too. Therefore employers will pay the gross-up on the gross-up. To determine the amount, add up all the tax rates (fed, state, OASDI, SS) and then divide the taxable expense by the sum of the tax rates. Take this number and subtract the taxable expense.
This methodology covers gross-up on the gross-up, but 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:
Gross-Up Formula #3 - The Marginal/Inverse Method
This method is typically handled by a CPA or full-service relocation companies and also incorporates the tax on tax calculation. The difference is this 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.
These three tax gross-up formulas represent the essentials of grossing up taxable relocation expenses to assist with the employee's relocation tax liability. While one can do the calculations, it is always wiser to seek the help of experienced relocation experts.
5 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, that if not done correctly, can result in a relocation tax gross-up error.
- Determine if your company should handle relocation tax itself or give the job to a trusted advisor.
- Work with an experienced global mobility management company that can efficiently handle all aspects of a your mobility program.
- For more information in eliminating tax errors and omissions, partner with a good global relocation company that will track expenses and submit accurate reports of taxable costs and help to calculate tax gross-up.
Mishandling Tax Gross-up
When done properly, a tax gross-up can reduce the tax burden on a transferee and offer consistency in records and paperwork to better prepare both the employee and employer for tax filing. That said, if not done correctly, a relocation tax gross-up can result in the following problems:
- Extra work and time (read: increased company expenses) as well as frustration for your accounting and HR departments as they need to take the time and effort to go back into their records to recalculate and correct mistakes and possibly issue W-2C forms.
- Failing to offer a tax gross-up for relocation expenses or miscalculating a gross-up can diminish employee morale due to being unfairly taxed, resulting in lowered productivity and retention rates.
- An incorrectly filed tax gross-up may result in an employee having to request an extension for filing a tax return, creating filing delays that could carry penalties.
- In some cases, the employee may even have to go to the trouble of filing an amended tax return as a result of incorrect W-2 statements.
- A possible audit and/or tax penalties and other fines, perhaps for your transferee as well as the company.
The IRS has several publications concerning tax consequences of moving expenses, including the gross-up concept, in their Publication 521 "Moving Expenses" and Publication 523 "Selling Your Home." Both are recommended reading for transferees planning a job-related relocation move.
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.
Working with an experienced global mobility management company that can efficiently handle all aspects of a transfer may prove beneficial in eliminating tax errors and omissions. Among its many services, a good 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 give you and your transferees peace of mind – along with a lower tax bill.
- IRS Publication 521: https://www.irs.gov/uac/About-Publication-521
- IRS Publication 523: https://www.irs.gov/uac/About-Publication-523
Although this written communication may address tax issues, it is not a covered opinion as described in Circular 230. Therefore, to ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments), unless expressly stated otherwise, was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.