Understanding relocation and relocation gross-ups can be confusing. After reading this, you should have a much better understanding of relocation, tax gross-ups for relocation, and the methods to use to determine the gross-up.
How Relocation Taxes Work
Tax rates depend on many elements, like your location, your salary, your filing status, and a few other aspects that will determine which tax bracket your employees fit into. Any outside investments or incomes are usually not considered in relocation taxes. To understand how to gross up relocation taxes, you must know how your employee’s relocation tax situation is impacted by relocation.
First Example – Bob’s Relocation Reimbursement
Bob has a salary of $90,000. His W-2 reflects $90,000 in earnings in a typical year. However, Bob moved this year and his employer reimbursed him $3,000 for his moving truck and $700 for his relocation flight. Consequently, Bob’s W-2 will now show $90,000 plus $3,000 plus $700, coming to a total of $93,700. Bob will still need to pay taxes on $3,700 and cannot write off that amount as a moving tax deduction from his taxes.
Second Example – Mary’s Relocation Package
Mary also earns a $90,000 salary, but her employer has a different type of relocation package. When Mary relocated, an $8,000 relocation signing bonus was given to her from her employer and her employer also paid $10,000 for a moving company. Now, Mary’s W-2 will state that $90,000 plus $8,000 plus $10,000 comes to a total of $108,000 in earnings. She will now need to pay taxes on the $18,000 for her relocation benefits without being able to deduct it.
Both of these examples show how relocation is an expense for any employee and it is understandable how they might feel reluctant to relocate. If an employer uses relocation benefits as a way to hire their employees, they should at least take the steps to help their employees. Relocation tax gross-ups are a way the employer can help the employee.
What is Relocation Gross Up?
Simply put, a relocation gross-up is when an employer offers an employee the gross amount owed to them in taxes. With the help of the added gross income, your employees will feel relieved from the tax liability that comes with expenses from relocation. If your employee’s relocation costs $10,000 that can be taxed, the employer will pay the amount of $12,500 so the employee will get the complete benefit of the $10,000 since the approximate taxes in the amount of $2,500 are paid from the employer.
How Does a Tax Gross-Up Work?
Taxes from an employee’s paycheck are withheld by the employer because of government requirements. We live in a corporate world, where pretty much everything is taxed, as well as relocation packages for employees. Most relocation expenses that have to do with a move must be reported as taxable incomes to the employee and follow through with the IRS regulations for supplemental withholding.
When Do I Use a Relocation Gross Up?
Your employees will certainly be upset when they find out that the relocation bonus you provided is actually going to increase their taxes. Luckily, your employees can get a fragment of the tax liability from their relocation package covered by relocation tax assistance, or gross-up, by their employer. However, if the employee does gross-up, 55 percent or more can be added to their taxable costs of relocation. If you are looking to keep your employees happy, your money for a gross-up will be put to good use.
Methods for Relocation Tax Gross-Up
There are 3 methods of tax grossed up relocations that are commonly used today.
1. The Supplemental Method
The supplemental method is usually used because the employee’s relocation expenses and gross-up are considered income. Essentially, the employer will pay the gross-up on the gross-up. With the supplemental method, you will need to identify all your taxes, divide the taxable expense by the sum of the tax rates and take that number, and minus it from the taxable expenses.
Example of The Supplemental Method
Taxable Amount – $7,000
Federal – $546.89
Local – $0
State – $90.43
Medicare – $29.84
OASDI – $295.15
Total Taxes or Gross Up – $962.31
Total Wages – $7,962.31
This example shows gross-up on gross-up but might not accurately show the tax bracket of your employee. In order for this method to be completed, you will need to have more income information for their tax liability to make the transferee whole.
2. The Flat Method
The flat method is a flat percentage that is calculated on taxable costs and then added to the employee’s income.
Example of The Flat Method
An employer will gross-up at a 30 percent rate for taxable costs. If the transferee is paid $2,000, the gross-up is 30 percent of this, or $600, and the transferee will receive a benefit totaling $2,600. It is important to remember that the gross-up is considered taxable income and could create an added liability for the transferee. This method most likely will not cover the tax liability of the employee because the gross-up is considered taxable income.
3. The Marginal Method
The marginal method is usually handled by a certified public accountant or by a full-service relocation or moving company and will incorporate the tax on tax calculation. This method takes into account the employee’s income and IRS form 1040 filing status. Typically, this policy states that only income earned from the company will be accounted for and other types of income, such as investment income or spousal income, will not be considered. The marginal method is probably the most used method out of the three.
Let’s take a look at some frequently asked questions regarding relocation gross up.
What relocation expenses are taxable?
Relocation expenses paid by an employer to an employee are all considered taxable income by the IRS and state authorities.
How do I calculate a relocation gross up?
To calculate a relocation gross up, take one minus the tax rate and divide the taxable expenses by that amount.
How does tax gross up?
A gross up is when the gross amount of a payment is increased to account for the taxes withheld from the payment. After taxes are withheld from the payment, the net amount should come out to the amount you guaranteed. The gross up reimburses the employee for the withheld taxes.
Now that you have a better understanding of tax relocation gross ups, you should feel a little bit more confident about your employees relocating for work. If you are planning an employee relocation, schedule a call with ARC Relocation today to discuss your business and corporate relocation needs.