If your corporate relocation program includes monetary help for transferees who rent or lease their residence, a gross-up feature that mitigates income tax consequences for relocating employees is a welcome benefit. Prospective transferees in the middle of an active lease will be particularly grateful; at least until they learn that reimbursement to buy-out their remaining lease costs may increase their income tax liability.
Relocation program expenses increase transferees' income, making these reimbursements subject to tax withholding. To avoid negative perceptions and eliminate some of the natural stress that accompanies relocation, tax gross up features help attract new talent and keep already high performing employees.
Three Methods to Gross Up Lease Payments
Whether you administer your relocation program internally using your HR department personnel or partner with a top relocation management company (RMC), you'll typically have three options to include a gross up component to help assist with potential tax consequences for your relocated employees.
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
These three methods can be used for all taxable reimbursed expenses, in addition to lease payments, that generate increased tax liabilities for transferred employees. The techniques herein described, particularly the Supplemental/Inverse and Marginal/Inverse methods, will help you attract new talent and retain historically top performing employees.