Gross-Up

What is the meaning of Gross-Up?

A Gross-up is defined as additional money that an organization pays an employee to balance any additional income taxes the employee could owe the IRS when they receive a cash benefit from the organization. It is usually seen in executive compensation plans, such as when an executive needs to relocate, and there are relocation expenses plus a gross-up to balance the expected income taxes. 

How to utilize Gross-Up

Grossing up an employee’s paycheck simply means computing a paycheck but in reverse. Usually, employees are paid a gross amount from which deductions are made later on, like taxes, social security, and retirement funds. The remainder after the deductions is referred to as net pay. Under a gross-up setup, the desired net pay is determined in advance, and the gross amount is increased and balanced to make sure the correct net pay is given to the employee.

Grossing up is normally used for one-time payments, such as reimbursements for relocation expenses or end-of-year bonuses. And depending on a company's calculation method, an employee may still have an additional tax liability.

Advantages of Grossing-up

The benefits for employees are obvious – more money in their pockets, net of tax. Grossing up lowers the employee’s tax burden, which can also help increase employee satisfaction and encourage loyalty. 

It can also help employees afford personal health insurance in the instance that the company does not offer it. Rather than paying the premium and treating the payment as a deductible business expense, the employer increases the employee’s salary by the premium amount. It then deducts the disability premium from the employee’s after-tax pay and pays the amount to the insurance company. The employer deducts the amounts of the grossed-up pay as wage, and because the employee has technically paid the premium with their own after-tax dollars, the benefits paid under the policy are considered to be tax-free.

Disadvantages of Grossing-up

Grossing up doesn’t necessarily eliminate all of the employee’s tax liability related to a non-salary payment. In some instances, grossed-up wages can push an employee into a higher tax bracket, which means owing more on taxes.

Conclusion

There is no universal way to calculate gross-up, and there are several methods that can be applied that largely depend on the employee’s goals. It’s important for the HR/Payroll and Finance teams to be aware of their company’s tax responsibilities and apply them accordingly. Having a full understanding of the rules around taxes is essential, and it’s a major responsibility for employers who must follow all requirements in a timely manner to avoid paying penalties. When it comes to employees’ pay, it’s always best to consult with the appropriate professionals to determine the best approach for each employee’s circumstances.