Gross-up is the gross financial relief a company offers an employee, that will be due on their taxes, after a relocation has occurred. Its purpose is to relieve the employee of the tax burden associated with their relocation expenses paid on their behalf by their company.
For example, if a relocation costs includes $5,000.00 taxable dollars, the employer may pay a total of $7,500.00 so that the employee gets the full benefit of the $5,000.00, as the estimated taxes of $2,500.00 are paid by the employer.
The IRS requires that the employer withhold taxes from the employee’s paycheck. In the course of a relocation, practically everything is taxable and must be treated correctly. Most relocation expenses associated with a move, whether it is a reimbursement made directly to the transferee or paid to an outside vendor for services on the transferee’s behalf, is required to be reported as taxable income to the employee and is subject to IRS supplemental withholding regulations.
Just think about your transferee’s blood pressure when you gently explain that the generous relocation bonus, the closing costs, the shipment of their household goods, their temporary living, their loss on sale bonus will increase their tax burden? It is a guarantee, their blood pressure just sky-rocketed, but their attitude about the company may have just changed.
Fortunately, for transferees, a portion of the tax liability of the relocation package can be covered by tax assistance (gross-up) paid by the employer. Unfortunately, gross-up can add 55% or more to taxable relocation costs, however, if you consider the obvious benefit to the transferee’s long-term happiness, it is money well spent.
What methodology for gross-up should I use?
There are three popular types of gross-up used in today’s relocation industry:
- The Flat Method
- The Supplemental/Inverse Method
- The Marginal/Inverse Method
Let’s take a quick look at each type to give you a basic understanding of how they work.
The Flat Method: is a flat percentage calculated on the taxable expenses and then added to the income. For example, an employer may gross-up at a 28% for taxable expenses, meaning if a transferee receives a $1,000 paid benefit, the gross-up would be 28% of this, or $280, and therefore, the transferee would receive a benefit totaling $1,280.00 total. An important note to this is, the gross-up is also considered taxable income and may create an additional tax liability to the transferee. Most likely, this option does not cover the employee’s tax liability since the gross-up is taxable. Additionally, this method is not compliant with supplemental withholding regulations.
The Supplemental/Inverse Method: is often used because not only are the relocation expenses considered income, but the gross-up is too. Employers will pay the gross-up on the gross-up. Work with your payroll department to identify all the taxes (e.g., fed, state, OASDI, SS) and then divide the taxable expense by the sum of the tax rates. Then, take this number and subtract the taxable expenses.
Here’s an example of how the methodology works:
Taxable Amount: $ 5,000.00
Federal: $ 642.37
State: $ 84.82
Local: $ -0-
OASDI: $ 217.10
Medicare: $ 28.72
Total Taxes (Gross-up): $ 973.01
Total Wages: $ 5,973.01
This methodology covers gross-up on the gross-up but may not accurately reflect the tax bracket of the employee. To complete this method, you will need to have additional income information and output information to make the transferee “whole” for their tax liability.
The Marginal/Inverse Method: is typically handled by a CPA or a full-service RMC and also incorporates the tax on tax calculation. The difference is this method takes into account employee income and IRS Form 1040 tax filing status. In most cases, policy dictates that only company-earned income will be considered and other forms of income, such as spousal income or investment income, won’t be taken into account. This methodology is probably the most common used today.
How do I decide which methodology to use?
- Decide on which formula best represents your company culture and business objectives,
- Review common relocation tax mistakes to avoid, that if not done correctly, can result in a relocation tax gross-up error,
- Determine if your company should handle relocation tax itself or through your RMC,
When properly prepared, tax gross-up can reduce the tax burden on a transferee and offer consistency in records and paperwork, to better prepare both the employee and employer for tax filing. If not done properly serious problems may result and cause, a recalculation and corrected W2 be prepared (W-2C), the need for an extension and possible penalties to be paid, or even an audit and/or tax fines, perhaps for both the company and the transferee.
Bottom Line to Relocation
Work closely with your RMC partner and your tax/payroll staff to ensure that your tax method is accurate, and everything is reported correctly, for you and your transferees, to the IRS.
Have questions or want to learn more about Lawrence Relocation Services, please click here to email Ginny Taylor, Relocation Services Director,