When companies provide executives and other highly paid employees with one-time payments, such as a bonus or severance package, it’s not uncommon for them to agree to a net figure. All applicable taxes, however, must still be paid. To do that, employers will “gross up” the agreed-upon compensation.
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What is a tax gross up?
A tax gross up is a calculation that starts with an employee’s desired net payment. The employer then calculates the following amounts to determine the gross payment:
- Federal income tax
- Social Security tax
- Medicare tax
- State and local taxes, if applicable
- Other deductions, if applicable
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Normally, employers start with a gross payment and calculate and withhold taxes and deductions. The amount remaining is the employee’s net or take home pay. Grossing up compensation is essentially the reverse of this process. Employers start with net pay and calculate the gross pay that would result in the desired take home pay after all taxes and deductions.
What types of compensation are most commonly grossed up?
Gross ups are usually applied to one-time payments, such as:
- Bonuses
- Severance payments
- Relocation expenses
How is gross up calculated?
To gross up a payment for income tax, employers subtract the tax rate from 1 and divide it into net pay. The gross-up calculation looks like this:
Net pay / (1 – tax rate) = gross pay
Other gross-up calculation considerations
Certain types of one-time payments may be considered supplemental income. In such instances, the employer must apply the supplemental tax rate rather than the employee’s regular income tax rate. Employers also need to consider whether to gross up compensation for Medicare tax, Social Security tax, and state and local taxes.
Mishandling tax gross up
It’s important for employers to plan for the tax liabilities associated with gross up payments before agreeing to them. If their budgets don’t include the taxes owed on net payments to employees, they may not be able to cover the costs and the financial health of their business may suffer.
Frequently asked questions about gross ups
How much can you gross up?
Employers can choose to gross up all or a portion of the tax liabilities for a sufficient payment.
Can an employer gross up a bonus?
Yes, bonuses and additional one-time payments that an employee receives are common examples of compensation that may be grossed up.
What is a tax gross-up clause?
Contracts between employers and employees may stipulate that certain compensation will be provided in an exact amount without deductions. This provision is known as a gross-up clause because the employer must gross up the payment to account for the requisite tax withholdings.
How do you gross up tax exempt wages?
Wages may be subject to some taxes and exempt from others. Employers can gross up wages only for the taxes that apply.
Can you gross up a taxable fringe benefit?
Employers may gross up fringe benefits after determining their full taxable value.
This guide is intended to help analyze the gross up meaning and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
