What does gross-up mean?
We’ve covered everything you need to know about how to gross-up, from how it affects your income to how to calculate it and when it’s applicable.
Gross refers to the total amount prior to deductions or expenses.
A gross-up adds an amount of money to a payment to cover income tax.
Employers and employees need to know how about grossing up.
Gross-up calculations can be complicated.
A financial advisor can help you to navigate the complexities of gross-ups.
What does gross mean?
In the world of finance, compensation, and taxation, you may well have encountered the term “gross-up” but been unsure of its meaning. Before we get to that, we need to answer the question: what does gross mean?
The term gross refers to the total amount of income prior to subtracting deductions or expenses.
In business, gross revenue is the total income generated by a company, not accounting for the cost of raw materials, direct labor costs, and manufacturing overhead costs. In personal income terms, gross income is an employee's total earnings before deductions, such as taxes and Social Security.
In circumstances where an employer must make an agreed once-off payment – such as a bonus, severance payment, or the reimbursement of relocation expenses – the employer will “gross-up” the payment to ensure that the employee receives the net amount agreed to. This is achieved by the employer increasing the employee's compensation to offset the additional tax burden that the employee will incur on receipt of that income.
Simply put, a gross-up is used to add an extra amount of money to a payment to cover the income tax an employee will owe the IRS on that income.
How does your employer calculate a gross payment?
There are different variables that an employee must take into account when calculating a gross payment. These include mandatory deductions such as federal income tax, Medicare tax, and Social Security tax, as well as state and local income taxes and wage garnishments (where applicable).
Depending on the nature of the once-off gross payment (a severance payment, for example), the employer may negotiate with the employee to determine whether to include voluntary deductions, such as health insurance, life insurance, and retirement plans, in the gross-up calculation.
State wage deduction laws also determine what deductions may be taken from wages, and some states include severance pay within their definition of wages, while others do not. This could mean that the deduction is allowed or not, which further impacts the gross-up calculation.
Some once-off payments may be determined to be supplemental income, in which case the employer must apply the supplemental tax rate instead of the employee’s regular income tax rate in the gross-up calculation.
These variables illustrate that gross-up calculations can be complex. A financial advisor can assist you or your company in negotiating the intricacies of tax codes, employment laws, and financial planning that are inherent in grossing up.
How do gross-ups work?
Employers usually calculate salary payments by starting with the employee’s gross (total) compensation amount and subtracting applicable taxes and deductions. The remaining amount is then paid to the employee as their net or take-home pay.
A grossed-up payment turns this process upside down by starting with the stated net pay and adding the relevant tax and deduction amounts to that figure to ensure that the employee actually takes home the amount agreed to.
A gross-up calculator example best illustrates the process of working out a payment:
A company wishes to relocate an employee from Florida to Georgia and agrees to reimburse the employee’s relocation expenses of $10,000.
To ensure that the employee is fully reimbursed, the company must gross-up the $10,000 to compensate for the subtraction of income taxes and other deductions.
A gross-up calculator uses the following steps:
Gross pay = net pay / (1 – tax rate)
Add all the applicable tax rates:
Federal income tax: 24%
Social Security tax: 6.2%
Medicare tax: 1.45%
Total tax rate: 31.65%
Convert the total tax rate to a decimal = 0.3165
Subtract 0.3165 from 1 = 0.6835
Divide the net pay by 0.6835 = 14,630.58
The grossed-up amount due by the company to the employee to reimburse their relocation expenses is $14,630.58.
A financial advisor you can trust can help you to navigate the complexities of gross-ups. By answering just a few questions, we’ll help you to connect with an SEC-regulated financial advisor that’s perfectly suited to your needs. Get matched with an advisor.
What are the pros & cons of gross-ups?
Like any financial tool, there are pros and cons to using gross-ups. Here are some pros and cons for both employees and employers:
Pros for employees:
Gross-ups help employees receive the intended net pay, even after taxes and deductions have been taken out.
Gross-ups help employees avoid unexpected tax bills.
Gross-ups help employees better understand their compensation packages.
Cons for employees:
Gross-ups can be confusing and difficult to understand.
Gross-ups are usually a one-time increase or payment that cannot be relied upon long-term.
Gross-ups can increase the tax liability for employees in the future.
Pros for employers:
Gross-ups help attract and retain top talent by offering competitive compensation packages.
Gross-ups help employers comply with tax laws and regulations.
Gross-ups help employers avoid disputes with employees over taxes and deductions.
Cons for employers:
Gross-ups can be expensive, especially when used frequently.
Gross-ups can be time-consuming and complicated to calculate.
Gross-ups can increase administrative costs.
It is important to research and take these variables into account before dealing with gross-ups.
Need advice on grossing up?
Employers and employees need to understand what gross means because it serves as the foundation for calculating various forms of compensation, and it’s a critical component in gross-up calculations.
While gross-ups ensure that employees receive their desired net amounts after taxes, they come with their own set of pros and cons that must be carefully considered. Whether you are an employer offering compensation packages or an employee receiving income or benefits, understanding the concept and potential use of gross-ups is vital for efficient financial planning and management.
Speaking to an expert financial advisor is the best thing to do when dealing with complex financial matters. They can help you understand the complex world of gross-ups and ensure your calculations are correct. Find a financial advisor best suited to your needs, answer a few simple questions, and we will connect you with an SEC-regulated financial advisor. Get matched with an advisor.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.