Relocation Tax Gross Up 101

thWhat is tax gross up?  A tax gross up means the company has increased an employee’s pay, bonus, or any other taxable income so the employee doesn’t actually pay his/her own (estimated) tax. If they are told they are getting a million dollar bonus, the tax gross up means they actually get a check for $1 million after taxes.  As most relocation costs are considered income to the transferee and subject to tax, tax gross up has the potential to greatly increase a corporation’s relocation cost.

Tax gross up is a legal business practice. If it is not done correctly, it can result in an audit and can bring adverse affects on your transferring employee and your corporation. An incorrectly filed tax gross up could mean employees might have to file a tax extension. In some cases, they might need to file an amended tax return owing to wrong W-2 statements.  It’s advisable to hire services from a third party relocation management company that offers gross up tax assistance.

Gross-up/tax assistance on taxable relocation expenses is not required by the IRS; gross-up is a benefit that a company chooses to give to transferees who qualify. Most relocation policies offer some sort of tax assistance to transferees so their out-of-pocket tax costs due to the relocation are eliminated or reduced.  One thing to keep in mind is that the gross-up payment itself also is taxable to the employee and subject to withholding and payroll tax. Therefore, to fully tax protect the employee, the gross-up must itself be “grossed up,” and the gross-up of the gross-up must be grossed up, and so on.

There are a few different methods used to calculate the gross up (inverse method, true up and simple method) and depending on how a company calculates the gross up, an employee may still end up owing money at tax time.  Below is a comprehensive explanation of how each method applies to income.  Managements generally maintain that the tax gross-up is a valuable tool for hiring and retaining talented executives. It is generally accepted within the relocation industry that transferees should not have to absorb the stress of relocation and suffer financially as well.

If an employee receives $10,000 in reimbursement for relocation expenses, that money is subject to taxes. If the employee’s tax rate is 25 percent, $2,500 in taxes would be due. Three methods are commonly used to calculate gross up: simple gross up, the inverse method and the true-up method. Simple gross up uses an arbitrary fixed percentage to determine reimbursement. The inverse method, which is generally more accurate, considers the effects of additional taxes and allows for timely tax reporting.  With the true-up method, calculations are done at the time the relocation expense is incurred as well as at the end of the year before earnings are reported on the employee’s W-2.

Simple Gross-up Method

Determine the gross-up percentage. For example, many human resources departments may use a supplemental tax rate for the income bracket, such as 25 or 35 percent.

Multiply the amount of taxable reimbursement by the gross-up percentage. The result is the gross-up amount.

Pay the gross-up amount to the employee along with the taxable reimbursement. If an employee receives $15,000 in taxable reimbursements and the company uses a gross-up rate of 25 percent, the employee would receive $3,750 in gross up. Both the $15,000 and the $3,750 gross-up amount are subject to tax.

Inverse Method

Determine the employee’s tax rate by combining his/her federal, state and local tax rates. The inverse method covers taxes on the gross-up amount to more closely approximate and cover the true tax liability.  The taxable expense is divided by the sum of the tax rates and the resulting number subtracted from the taxable expense.  This gives you the gross up amount.

True-Up Method 

Calculations are done at the time the relocation expense is incurred as well as at the end of the year before earnings are reported on the employee’s W-2.  It’s important for all transferring employees to consult with a tax professional to ensure they are filing correctly and getting the best tax advice.

The information in this blog post is for general informational purposes only.  The reader should not rely or act upon any information contained in this post  without seeking advice from his or her tax professional.
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