A gross-up refers to the extra amount of money that an employer adds to a payment given to an employee to make up for the taxes that must be withheld from the payment. The main concept behind grossing up a payment is reimbursing the employee for the taxes that they will owe on the payment.
When you are given an amount of money from your employer, let’s say a bonus, you will not receive that money in full. It will be subject to income taxes, right? The bonus will be taxed by the IRS. However, if your employer wants you to receive a specific amount as your bonus, that is what a gross-up is for. A gross-up is that additional amount that is given on top of the intended bonus. The purpose of this extra amount is to cover the taxes that will be withheld from your bonus. In this way, you will still be able to receive the desired amount promised to you even after withholding taxes.
A gross-up is typically seen in one-time payments in executive compensation plans. Bonuses, reimbursement for relocation expenses, and other one-time payments are some examples. Keep in mind though that a gross-up is not mandatory. It is an option that employers may or may not do.
To make it clearer, let’s have an example:
Victor’s company is relocating him to another state. The company will shoulder the relocation expenses which amounted to $3,500. Upon receiving the relocation reimbursement, Victor noticed that, instead of $3,500, the amount was $4,500. Victor’s company decided to not only pay the relocation expenses, but also the taxes that Victor would have paid for the relocation amount. The gross-up covered Victor’s taxes on the one-time payment.
When can employers provide a gross-up to employees?
As we have mentioned above, a gross-up is optional and not mandatory. It is up to the discretion of the employer whether to do a gross-up or not. Here are examples of situations when an employer might provide a gross-up to employees:
The employer is giving a year-end bonus.
The employer is covering the expenses for the relocation of an employee.
The employer wants to help in the tax burden of an employee who is receiving short-term or long-term disability payments.
The employer wants to include a gross-up in an executive’s compensation plan.
The employer wants employees to receive a specific net salary.
The employer does not have group life insurance for employees so a gross-up is offered to cover their personal health insurance.
What are the benefits of a gross-up?
As in most strategies and actions, offering a gross-up has its benefits and drawbacks. For employers, giving a gross-up to employees can help ease their tax burden and allow employers to give a specific net pay. It is also a way of covering personal health insurance if the company does not have group life insurance coverage. A gross-up helps employees because it can result in an increase in the pay that they take home. Having a gross-up also helps decrease the taxes that they have to pay on their own.
What are some potential drawbacks of a gross-up?
For employers, a gross-up is typically provided for one-time payments as in year-bonuses or relocation reimbursements. However, some employers may find it challenging to give a gross-up only once. Employees may have high expectations that a gross-up will be given more frequently. This can be an added pressure to the company, especially as the company expands and hires more employees. A gross-up that is used to cover personal health insurance may also be more costly in the long run. Compared with acquiring group life insurance, a gross-up may be more expensive. For the employee, they can still have an additional tax liability on the gross-up amount. This can happen if progressive income tax rates apply in the state where they are located.
How is a gross-up calculated?
Here are the steps that show how a gross-up is calculated:
Take the sum of all the tax rates that will apply to a worker’s wages. These are:
Federal supplemental tax rate: 22%
Social Security tax rate: 6.2%
State Supplemental tax: the rate will depend on the specific state.
2. Convert the tax rate into a decimal. To do this, move the decimal point two places to the left. 3. Once you have the decimal tax rate, subtract this from 1. This will give you the net percent. 4. Divide the net wage by the net percentage. This will give you the gross amount that you need to give the employee (with the gross-up). Here is a sample calculation:
You are an employer of a small business. You want to give your top employee, Emil, a bonus of $500 but you want to make sure that $500 is the net bonus that Emil gets to take home. What is the gross-up amount?
Add up all the tax rates that will apply.
Federal supplemental tax rate: 22%
Social Security tax rate: 6.2%
State Supplemental tax: 5% (this is just an example)
22% + 6.2% + 1.45% + 5% = 34.65%
Convert the tax rate into a decimal. Move the decimal point two places to the left.
34.65% will become 0.3465
Subtract the decimal rate from 1 to get the net percentage.
1- 0.3465 = 0.6535
Divide the net wage ($500) by the net percentage.
500 ÷ 0.6535 = 765.11
You must pay Emil the gross-up amount of $765.11 so he can receive the net bonus of $500.
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