Glossary of Human Resources Management and Employee Benefit Terms
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 optional and is usually used for one-time payments. However, there are times when it is 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).
To help illustrate gross-up, here is 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 equaled $4,000. This is because The Jones Company didn’t only pay for his moving expenses, but also for the withholding tax Cecil would normally owe on the $3,000 benefit he received. Now Cecil doesn’t owe any income taxes on his reimbursement.
Examples of when an employer might offer a gross-up payment to employees:
An employer wants to give an employee a specific amount, which the employee wouldn’t normally receive because of tax withholdings.
A bonus check is granted.
An employer pays for an employee’s relocation expenses.
An employer is contracted 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.
There are some definite pros and cons of grossing up salary or other payments, both for employers and employees.
For the employer
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.
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 again and again. 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.
Job candidates may be more likely to go with a company that offers formal health benefits.
For the employee
More take-home pay is received and fewer taxes are paid.
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.
It is 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 is 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 any time with or without notice.
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 gross-up compensation contracts, an employer may want to include a gross-up clause.
To calculate $500 bonus grossed-up, follow these four steps:
Add together all applicable tax rates, which are Federal Supplemental tax rate = 22%, Social Security tax rate = 6.2%, Medicare = 1.45%, and State Supplemental tax = 0%, so 29.65%.
Convert the tax rate into a decimal, so 29.65% = 0.2965.
Subtract the decimal tax rate from 1 (1 - 0.2965 = 0.7035).
Divide the net pay by 0.7035 (500 / 0.7035 = 710.73).
Therefore, the total grossed-up bonus pay should equal $710.73 if it’s going to cover taxes.
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