Why Do Employers Gross Up for Taxes on Relocation Benefits?
Learn why employers gross up relocation benefits, how it impacts compensation, and what it means for employees receiving these payments.
Relocating for a job can be costly, and many employers offer financial assistance to help with moving expenses. However, these benefits are considered taxable income, meaning employees may receive less than expected after taxes. To prevent this, some companies provide a tax gross-up, covering the additional tax burden so employees receive the full benefit.
This approach eases the transition for employees while also serving as a strategic tool for businesses. Understanding why companies gross up relocation benefits sheds light on how they manage compensation and support their workforce.
Why Employers Pay the Extra Amount
Employers gross up relocation benefits to ensure employees receive the intended financial support without tax deductions reducing the amount. Without this adjustment, employees might receive significantly less, which could discourage them from accepting a job offer or relocating.
Beyond recruitment, covering these tax costs reinforces a company’s commitment to employee well-being. Moving is stressful, and unexpected tax liabilities add financial strain. By eliminating this burden, employers help employees focus on their new roles, improving job satisfaction and productivity.
Gross-ups also maintain consistency in compensation. If one employee’s relocation benefit is taxed while another receives a tax-free reimbursement, discrepancies arise, leading to dissatisfaction or even legal concerns. Standardizing the process ensures fairness and compliance with tax regulations, reducing the risk of disputes.
Calculation Steps
To ensure employees receive the full intended relocation benefit, employers follow a structured approach: identifying applicable tax rates, calculating the necessary additional payment, and verifying the final amount.
Determine the Tax Rate
The first step is identifying the total tax rate applied to the relocation benefit, which includes federal, state, and sometimes local taxes, as well as payroll taxes like Social Security and Medicare.
For federal income tax, the IRS requires a flat 22% withholding on supplemental wages up to $1 million (as of 2024). Earnings above this threshold are subject to a 37% withholding rate. State income tax rates vary, from 0% in states like Texas and Florida to over 13% in California. Employers must also account for FICA taxes: a 6.2% Social Security tax (up to the annual wage base limit of $168,600 in 2024) and a 1.45% Medicare tax, with an additional 0.9% surtax for earnings above $200,000.
Employers sum these percentages based on the employee’s location and income level. For example, if an employee in California has a combined federal, state, and payroll tax rate of 40%, the gross-up calculation must ensure the employee receives the full intended benefit after taxes.
Calculate the Gross-Up Amount
Once the total tax rate is determined, the gross-up amount is calculated using the formula:
Gross-Up Amount = Net Payment / (1 – Total Tax Rate)
For example, if an employer wants an employee to receive $10,000 after taxes and the total tax rate is 40%, the gross-up amount is:
10,000 / (1 – 0.40) = 10,000 / 0.60 = 16,667
This means the employer must pay $16,667 so that after $6,667 in taxes are deducted, the employee receives the full $10,000. Employers often use payroll software or tax calculators to automate this process.
Verify the Final Amount
After calculating the gross-up, employers verify that the final amount aligns with the intended benefit. This involves running payroll simulations or consulting tax professionals to ensure correct withholdings.
Grossed-up relocation benefits are reported on the employee’s Form W-2 as taxable income. Employers must also cover their share of payroll taxes, increasing the total cost. In the previous example, beyond the $16,667 gross-up, the employer also pays Social Security and Medicare taxes.
To prevent discrepancies, businesses often audit relocation payments and tax withholdings, ensuring employees receive the correct amount while maintaining compliance.
How It Reflects in Compensation
Grossing up relocation benefits increases an employee’s taxable income, which can push them into a higher tax bracket, affecting the percentage of income subject to federal and state taxes.
Since these payments are treated as additional wages, they can influence how employees perceive their total earnings. Compensation is often evaluated based on take-home pay rather than base salary. If a gross-up significantly raises taxable income, employees may assume their overall earnings have increased, even though the additional amount is only intended to offset taxes. This can create confusion when comparing job offers, especially if other employers do not gross up relocation benefits.
The impact extends to benefits tied to income levels, such as 401(k) contribution limits and income-based phaseouts for tax deductions. In 2024, the maximum 401(k) contribution is $23,000, with an additional $7,500 catch-up contribution for those over 50. Since gross-ups increase taxable wages, employees may be able to contribute more to retirement plans. However, they may also lose eligibility for deductions like student loan interest, which begins to phase out for single filers earning over $75,000.
Implications for Employees
Receiving a grossed-up relocation benefit can affect tax withholding throughout the year. Since the gross-up increases taxable income, employees may see higher withholdings on regular paychecks, impacting cash flow. If the employer applies a flat supplemental wage tax rate but the employee’s actual tax bracket differs, this could result in either a refund or an unexpected tax liability when filing a return. Adjusting W-4 withholdings can help mitigate this issue.
Gross-ups can also influence equity compensation plans. Many companies offer stock options, restricted stock units (RSUs), or performance shares based on salary levels. If a relocation payment inflates reported earnings, it could affect future equity grants, particularly if awards are calculated as a percentage of total compensation. This can benefit employees receiving stock-based incentives but may also create volatility in long-term financial planning if the increase is temporary.