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Payroll Taxes

  1. FUTA
  2. Form 4070
  3. Gross-Up

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Gross-Up: Definition & Calculation

Updated: November 24, 2022

There may be instances in which you wish to pay a worker a specified sum. However, the sum decreases when taxes are taken into account. So how do you pay a worker a specific net wage?

That’s just one example in which a gross-up may be necessary.

Read on as we take a look at exactly what a gross-up is, how it works, and how you can calculate it.

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    KEY TAKEAWAYS

    • A gross-up is an additional payment made to an employee, on top of their salary, to cover the taxes they will owe on their income.
    • Gross-ups are often used to attract and retain top talent, or to offset the cost of benefits packages.
    • Gross-ups can be a contentious issue, as some feel that they amount to preferential treatment for certain employees.

    What Is a Gross-Up?

    A gross-up is a reimbursement for taxes paid on another company’s benefit. Gross-up is an accounting term that means to increase something by its costs or expenses. A gross-up is also known as a reimbursement for taxes paid on another company’s benefit.

    Gross-up is a reimbursement for the cost of taxes paid directly from your own pocket when you take a particular type of compensation from the company you work for, such as an excess bonus or another non-standard form of pay. 

    This reduces your personal tax liability because, when you file your taxes, your final income has been adjusted upward to cover the cost of the taxes reimbursed from your employer. As an employee, you owe tax on any income and benefits you receive from your company. 

    If the value of that income or benefits exceeds certain thresholds, you may have to pay additional taxes called payroll taxes (or “self-employment” tax). The gross-up reimburses you for that additional cost so it doesn’t become an out-of-pocket expense.

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    How a Gross-Up Works

    A gross-up is a reimbursement for taxes paid directly from your own pocket when you take a particular type of compensation from the company you work for, such as an excess bonus or another non-standard form of pay. 

    This reduces your personal tax liability because, when you file your taxes, your final income has been adjusted upward to cover the cost of the taxes reimbursed from your employer. When you take an excess bonus or other non-standard form of payment, such as a payment in equity, you may owe additional taxes. 

    This is either because your income from the bonus exceeds certain thresholds, or because you have to pay self-employment taxes on your equity reward. A gross-up reimburses you for the additional cost so it doesn’t become an out-of-pocket expense.

    How Do You Calculate Gross-Up?

    As stated, the gross-up calculation can get complicated. But essentially it involves taking into account the employee’s tax rate and adding that amount to their salary. For example, if an employee has a marginal tax rate of 30%, a gross-up of $10,000 would result in a net pay increase of $7,000 (after taxes).

    To calculate the gross-up, you first need to determine the employee’s marginal tax rate. This is the rate at which their last dollar of income will get taxed. Marginal tax rates vary depending on the employee’s income and filing status. You can use an online marginal tax calculator to determine the marginal tax rate.

    Once you have determined the marginal tax rate, you can calculate the gross-up considerations. To do this, simply multiply the marginal tax rate by the amount of the gross-up method. For example, if the marginal tax rate is 30% and the gross-up pay amount is $10,000, the calculation would be as follows:

    30% x $10,000 = $3,000

    This means that the employee would receive an additional $3,000 to cover their taxes. The net pay increase would be $7,000 (after taxes).

    A net pay increase is the amount of money an employee receives after taxes get deducted from their salary. To calculate a net pay increase, you need to take into account the employee’s marginal tax rate.

    This is the rate at which their last dollar of income will get taxed. Marginal tax rates vary depending on the employee’s income and filing status. You can use an online marginal tax calculator to determine the marginal tax rate.

    Once you have determined the marginal tax rate, you can calculate the net pay increase. To do this, simply subtract the marginal tax rate from the amount of the gross-up provisions. For example, if the marginal tax rate is 30% and the gross-up amount is $10,000, the calculation would be as follows:

    $10,000 – 30% = $7,000

    This means that the employee would receive a net pay increase of $7,000 after taxes get deducted from their salary.

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    Example of Grossing-Up

    John is in the 40% marginal tax bracket and his employer offers him a gross-up of $10,000. To calculate the net pay increase, John would subtract 40% from the gross-up amount, which would give him a net pay increase of $6,000.

    Another example:

    Mary is in the 33% marginal tax bracket and her employer offers her a gross-up of $15,000. To calculate the net pay increase, Mary would subtract 33% from the gross-up amount, which would give her a net pay increase of $10,050.

    Employers often use gross-ups to attract and retain top talent, especially in high-tax brackets. They may also offset the cost of benefits packages, such as health insurance or retirement plans.

    Let’s look at one more example of a gross-up situation.

    Suppose an employee is in the 25% marginal tax bracket and their employer offers them to gross-up the salary to $10,000. To calculate the net pay increase, the employee would subtract 25% from the gross-up amount, which would give them a net pay increase of $7,500.

    Some people feel that gross-up adjustment clauses are unfair. This is because they could amount to preferential treatment for certain employees. However, employers often use gross-ups to attract and retain top talent, especially in high-tax brackets. They may offset the cost of benefits packages, such as health insurance or retirement plans.

    Summary

    Gross-up pay works to describe the process of increasing an employee’s salary to cover the taxes they will owe on the additional income. To calculate gross-up reconciliations, you first need to determine the employee’s marginal tax rate. 

    This is the rate at which their last dollar of income will get taxed. Marginal tax rates vary depending on the employee’s income and filing status. You can use an online marginal tax calculator to determine the marginal tax rate.

    Once you have determined the marginal tax rate, you can calculate the gross-up by multiplying the marginal tax rate by the amount of the gross-up.

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    FAQs About Gross-Up

    What expenses can be grossed up?

    The most common expenses that gross-up are salaries, bonuses, and benefits packages.

    What is the difference between a gross-up and a net pay increase?

    A gross-up is an amount of money added to an employee’s salary to cover the taxes they will owe on the additional income. A net pay increase is the amount of money an employee receives after taxes get deducted from their salary.

    To calculate a net pay increase, you need to take into account the employee’s marginal tax rate. This is the rate at which their last dollar of income will be taxed. Marginal tax rates vary depending on the employee’s income and filing status. You can use an online marginal tax calculator to determine the marginal tax rate

    What is a tax gross-up clause?

    A tax gross-up clause is a clause in an employment contract that stipulates. The employer will pay the taxes on any benefits the employee receives. For example, if an employee is given a company car, the tax gross-up clause would stipulate that the employer would pay the taxes on the value of the car.

    Why do we gross-up non taxable income?

    We gross-up non taxable income because it allows the employee to receive the full value of the benefit without having to pay taxes on it. This is often used as a way to attract and retain top talent.

    What is a tax-free gross-up?

    A tax-free gross-up provision is an amount of money added to an employee’s salary to cover the taxes they will owe on the additional income. But the employee does not have to pay taxes on the gross-up itself. This is often used as a way to attract and retain top talent.

    Are gross-ups legal?

    Gross-ups are legal, but they can be a contentious issue, as some feel that they amount to preferential treatment for certain employees.

    Payroll Taxes

    1. FUTA
    2. Form 4070
    3. Gross-Up

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