Gross-Up

What Does Gross-Up Mean?

Gross-up is additional money an employer pays an employee to offset any additional income taxes (Social Security, Medicare, etc.) an employee would owe the IRS, when that employee receives a company-provided cash benefit, such as relocation expenses.

Gross-up is usually used for optional, one-time payments. However, there are times when it’s used to meet a specific annual net salary. When this happens, gross-up merely restates the salary as net instead of gross salary (before tax withholding).

If you’re new to tackling payroll, terms like gross-up may be causing a bit of a headache.

Examples of Gross-Up

To help illustrate gross-up and how it works, here’s a common example:

The Jones Company relocates Cecil to Texas and pays for his moving expenses, which totaled $3,000. Cecil receives the relocation reimbursement on his paycheck, but when he looks at his paystub, he notices that the amount paid to him is $4,000.

This is because The Jones Company paid for his moving expenses, and also for the withholding tax Cecil would normally owe on the $3,000 benefit he received. This ensures that Cecil is fully reimbursed for the actual cost of moving, even after taxes.

When Might an Employer Offer a Gross-Up to Employees?

Examples of when an employer might offer a gross-up payment to employees:

• An employer wants to give an employee a specific amount; a gross-up ensures they still get the intended amount after taxes.
• An employee earns a bonus.
• An employer pays for an employee’s relocation expenses.
• An employer is contractually obligated to pay an employee a specific net salary.
• It’s included in a compensation plan (generally for executives).
• The employer can’t afford, can’t meet minimum participation requirements, or doesn’t know how to implement group health insurance. In this case, the gross-up is meant to help employees cover their personal health insurance.
• An employer wants to ease the tax burden of an employee receiving short-term or long-term disability payments.

What Are the Pros and Cons of Grossing Up Salary?

There are some definite pros and cons of grossing up salary or other payments, both for employers and employees.

For the Employer

Pros

• It helps lower employees’ tax burden, which in turn can increase employee satisfaction and encourage loyalty.
• It can be a way to help employees afford personal health insurance if the company doesn’t offer group coverage.

Cons

• It takes a few more steps to calculate and get the correct gross pay.
• It’s hard to offer this benefit only once, as employees will begin to expect it. This is especially difficult when the company grows and adds more employees.
• If used to help with health insurance costs, it can end up being more expensive than simply offering health insurance benefits, and job candidates may be more likely to go with a company that offers formal health benefits.

For the Employee

Pros

• Employees receive more take-home pay.
• It covers the actual costs of one-time expenses (moving, travel, other reimbursements, etc.)
• It can help cover the cost of obtaining personal health insurance.
• It increases the amount of short- and long-term disability payments received.

Cons

• It’s possible that some taxes will still be due on the gross-up amount if progressive income tax rates apply in your state.
• Voluntary deductions, including health insurance or retirement plan premiums, will still apply to grossed-up wages.
• It’s usually just a one-time increase that can’t be counted on long-term. If it is considered long-term, an employer can end it at any time with or without notice.

How Does a Gross-Up Work?

Gross-up pay works by dividing the employee’s wages by the net percentage of taxes that would be due. The total equals the gross-up pay amount.

All regulations must be followed, including the “Executive Compensation and Related-Party Disclosure,” of which one of the main requirements is to disclose a named employee’s tax gross-ups that exceed $10,000 in one year on company financial statements. Additionally, for some compensation plans, an employer may want to include a gross-up clause.

How Do You Calculate Gross-Up?

To calculate $500 bonus grossed-up, follow these four steps:

1. Add together all applicable tax rates:
   1. Federal Supplemental tax rate = 22%,
   2. Social Security tax rate = 6.2%,
   3. Medicare = 1.45%,
   4. and State Supplemental tax = 0%, so 29.65%.
2. Convert the tax rate into a decimal, so 29.65% = 0.2965.
3. Subtract the decimal tax rate from 1 (1 - 0.2965 = 0.7035).
4. Divide the net pay by 0.7035 (500 / 0.7035 = 710.73).

Therefore, the total grossed-up bonus pay should equal $710.73 to account for taxes. Note that some states may have varying tax rates, so always check before carrying out your gross-up pay calculations.

Gross-Ups Don’t Have to Be…Gross

Payroll tasks can feel intimidating, but knowing exactly what these terms mean and what’s involved can get you started on the right foot. Take a look at our full HR Glossary featuring all the important HR terms you need to know.