We’ve been fielding a lot of gross-up questions since the Tax Cuts and Jobs Act (TCJA) took effect January 1. For the most part, moving expenses are no longer tax deductible and employees may face an increased level of tax exposure. Employers who gross up moving expenses must pad their relocation budgets to further insulate workers from personal tax liabilities.
The shift has prompted employers to re-examine policies and rethink rates; an exasperated few have asked, “Should I even bother with gross up?” Here are 5 things employers should understand:
1) The Importance of Gross-Up
As the war for talent rages, employers must recruit and retain high quality job candidates. A competitive relocation package, complete with tax compensation, can make or break a job offer. Despite recent changes to tax laws, employers are still grossing up expense reimbursements. According to a recent AIRINC report,*:
- 85% of employers plan to gross up moving expenses
- 4% will not gross up moving expense reimbursements
- 11% are still deciding
Relocating employees now shoulder a heavier tax burden. Competitive employers will provide much-appreciated financial relief.
2) Rate Options
How should you gross up expense reimbursements? There are many different options, but the three main ones are listed below. As you will see in #4, the rate you choose will have varying impacts on employees, as well as your bottom-line.
- The marginal rate is based on the employee’s actual tax status, and it takes into account the employee’s filing status and gross income.
- The supplemental rate is based on a set of standard withholding rates as determined by the Federal, State and Local governments.
- The flat rate is a specific rate that is determined by the employer.
3) Grossing Up the Gross-Up
Like the reimbursed moving expenses themselves, the gross-up to compensate for the additional tax burden is taxable. That leads to the question: Are you going to gross up the gross-up payment? If you want to fully tax protect your transferees, the answer would be yes. A vast majority of companies do gross up the gross-up.
- The inverse method accounts for the additional tax liability the gross-up payment creates, i.e. the tax-on-tax exposure. The inverse rate formula is: Tax Rate / (1-Tax Rate) = Inverse Gross-up Rate
- The flat method does not compensate for the tax-on-tax liability, but just uses the marginal, supplemental or flat tax rate to determine the gross-up amount.
4) The Impact of Your Approach
These examples demonstrate that the decision to use a certain rate can significantly impact the employee’s tax burden and the employer’s cost.
Scenario 1: Employee moves with family to Illinois.
- Tax filing status: Married Filing Jointly (MFJ)
- Gross annual income: $65,000
- Moving expenses reimbursed by employer: $10,000
Gross-up amounts:
Considering that the Marginal inverse rate ($3,263) is the closest to the employee’s actual tax liability:
- You would underpay the employee $803 by using the marginal flat rate.
- You would overpay the employee $197 by using the supplemental flat rate.
- You would overpay the employee $2,028 by using the supplemental inverse rate.
Scenario 2: Employee moves with family to Oklahoma.
- Tax filing status: Married Filing Jointly (MFJ)
- Gross annual income: $340,000
- Moving expenses reimbursed by employer: $30,000
Gross-up amounts:
- You would underpay the employee $7,659 by using the marginal flat rate.Considering that the Marginal inverse rate ($19,464) is the closest to the employee’s actual tax liability:
- You would underpay the employee $10,659 by using the supplemental flat rate.
- You would underpay the employee $7,002 by using the supplemental inverse rate.
5) Where Gross-Up is Going
Based on AIRINC’s report, 57% of companies use the supplemental rate while 32% use the marginal rate. However, this is shifting. Here are the trends we’re seeing as a result of tax reform:
- More companies are moving towards marginal rates
- More are calculating during year, avoiding year-end delta adjustments
- Some payrolls want to avoid delta adjustments, especially negatives
For those who are unfamiliar, a year-end delta adjustment compares the gross-up paid out during the year with a year-end reconciliation calculation, typically based upon marginal tax rates determined by the transferee’s gross income and marital status. The differences would be processed through payroll as withholding adjustments.
Relocation tax laws have changed, which means your gross-up approach may need to change, too. By understanding the five points above, you can determine how to best serve your job candidates, employees, and the bottom-line.
*U.S. Domestic Mobility: Impact of Recent Changes to U.S. Tax Laws; AIRINC 2018
