Employee Relocation
Tax Gross-Up 101
When companies facilitate employee relocations, they often encounter the concept of “gross-up” – a financial strategy designed to alleviate the tax burden on an employee for their relocation.
Below, the Employee Relocation Tax Gross-Up 101 article will detail:
What is Relocation Gross-Up Tax Assistance and How Does it Work?
Essentially, gross-up refers to increasing an employee’s relocation benefits to account for the taxes that will be owed on those benefits. By doing so, companies ensure that employees receive the full net intended value of their relocation package, allowing them to focus on their new role without the added stress of unexpected tax implications. This approach not only enhances employee satisfaction but also strengthens the company’s commitment to supporting its workforce during significant life transitions.
Tax gross-up can vary depending on various factors, such as employee location, company policy, relocation expense type, and tax regulations and rates. It is essential for companies to maintain detailed records of all gross-up calculations and payments to ensure transparency and compliance with tax regulations. Some companies offer no gross-up benefit, while others provide various forms of assistance, from minimal to making employees “whole.” This is typically spelled out in relocation policies.
3 Tax Rate Options for Gross-Up Calculations
Companies must determine the gross-up rate they want to use in their gross-up calculations.
1) Flat Rates
Flat or fixed rates are based upon a company’s relocation policy and applied across all gross-up calculations.
2) Supplemental Rates
Supplemental rates are based on a specific tax authority (i.e., State or Federal) and the rate set up by that authority for withholding on a supplemental or fringe benefit payment (i.e., 22% for Federal).
3) Marginal Rates
Marginal rates are more employee-specific and based on the actual tax brackets for the specific tax authority. The marginal tax rate is the rate at which the employee’s last dollar of income will be taxed. For example, federal tax has brackets of 10%, 12%, 22%, 24%, 32%, 35%, and 37%, which vary based on taxable income and filing status.
6 Common Gross Up Methods
When it comes to grossing-up taxes for employee relocation, there are several commonly used methods companies use to calculate the gross-up to ensure
additional tax liabilities do not burden employees.
TR = Tax rate
Net = Net amount to employee
Gross = Gross amount required to be paid
1) One Time Flat Rate Method
The flat method uses a flat percentage calculated on the relocation expenses and then adds this amount to the relocation expenses. This method calculates the tax one time on the taxable relocation expenses. This is as easy as it gets!
Pros: Easy to calculate, everyone is given the same rate.
Cons: No acknowledgement of different income tax brackets. Does not cover employee’s entire tax liability since gross-up is included in taxable income.
Example:
A rate of 20% is given to everyone based on company policy.
An employee has $20,000 in taxable relocation expenses.
The gross-up amount would be $4,000, calculated as follows:
$20,000
x .20
$ 4,000
2) Fixed Rate Inverse Method
This method is similar to the “One-Time Flat Rate Method” (above) except there is a “tax-on-tax” effect. The flat tax rate of 20% per the company directed policy remains the same in the example below.
Pros: Easy to calculate, and tax on tax protection
Cons: No consideration of different income tax brackets.
In our example above, it would be:
The formula is: Taxable Amount/(1 – TR)
$20,000/(1 – .20) = $25,000, resulting in a gross-up of $5,000. (vs. $4,000)
3) Inverse or Tax on Tax
This method is used to compensate for the additional tax liability created by the gross-up amount. Once the gross-up is calculated, this amount also becomes taxable wages, so a gross-up on the gross-up is done.
Pros: Compensates for additional tax liability.
Cons: May not accurately reflect the tax bracket of the employee.
Example:
The formula is: Net/(1-TR) = Gross
The relocation cost for an employee includes $20,000 in taxable dollars.
The employee’s tax rate is 24%.
Using the formula from above: $20,000 / (1-.24) = $26,316
Here is an easy way to verify:
Gross payment: $26,316
Tax rate: x 24%
Tax: $ 6,316
To summarize: (the net payment to the employee of:)
$26,316 – (the tax of:) $6,316 = (the original taxable relocation expense of) $20,000.
4) Marginal Rate Inverse Method
For this method, the tax rate percentage varies based on the employee’s income, and the inverse of that rate is used to determine the amount to reimburse the transferee.
Federal rates match the tax brackets at 10, 12%, 22%, 24%, 32%, 35% & 37%.
Pros: Considers different income tax brackets and generally IRS Form 1040 tax filing status.
Cons: Choosing a rate based on the employees’ gross income could provide an employee more gross up than needed. For example, an employee who is married and makes $49,000 appears to fall into the 22% bracket. However, itemized deductions and personal exemptions bring their taxable income down to the 12% bracket.
5) Tax Return Method or True Up
This method is used by CPAs and often by relocation management companies as part of the year-end true-up. The true-up process involves calculating gross up when the relocation expense is incurred and again at year-end as a final step before W-2 wages are reported. This is done to provide a more accurate calculation of tax assistance. The employees’ tax return is calculated BEFORE THE MOVE at the federal and state levels and then re-calculated AFTER THE MOVE. The DIFFERENCE becomes the gross-up.
Pros: More accurate and catches phase-outs of itemized deductions, child tax credits, personal exemptions, and state tax laws.
Cons: The company must decide if they want to perform the calculation using the employee’s income or all household income and how they will account for deductions (e.g., filing status and number of exemptions).
Generally, per company policy, the calculation only considers the employee’s company earnings and not spousal income or investment income.
6) Combination
A combination of the above methods may be used to calculate tax assistance based on a company’s relocation policies. For example, high-level executives may be eligible for the tax return method, while new hires may only be eligible for the one-time flat rate method.
Relocation Tax Gross-Up In Conclusion
All the above methods help reduce the tax burden for the relocating employees by shifting it to the company. An experienced global relocation company such as WHR Global can assist your company in determining which best practice in gross-up most closely aligns with your company goals.Ready to learn more about employee relocation tax gross-up?
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