2020 Year-End Gross-Up: 4 Things You Need to Do

12.29.2020 | This time of year we get a lot of questions about relocating employees and taxes. Since moving-related reimbursements mostly count as income, employers are looking to ease their employees' tax burdens through gross-up policies.

If you don't have a policy, or you just haven't gotten around to implementing it this year, don't panic. We've got your back. When employees are reimbursed for nondeductible relocation expenses, the reimbursement becomes taxable income. By grossing up the reimbursement amount, employers can reduce or mitigate an employee's tax burden that is the result of a relocation.

Here’s what you need to know about 2020 gross-ups, including COVID-related information that you should take into consideration.

1) Don’t overpay or underpay

When gross-up is not figured properly, it plays out in one of two ways: 1) The transferee is overcompensated, which is great for the employee but could put a financial strain on the company, or 2) The gross-up is not sufficient and the employee will face an unexpected – and unwelcomed – tax situation. Ideally, your gross-up approach should make the transferee whole without straining an employer’s bottom line.

2) Avoid the biggest mistake

Most employers base gross-up on an employee’s W-4; however, these usually do not reflect an individual’s true tax situation. We recommend using the 1040 and, as you can see from the following example, it makes a difference.

Example: W-4 vs. 1040 & Tax Filing Status

When Bill was hired, a W-4 was among the many forms he had to complete. Bill is married but in an effort to compensate for his spouse’s income, which places his household in a higher tax bracket, he claimed a “single” status.

Bill’s employer uses a marginal gross-up policy with an inverse rate. Here’s what it looks like when Bill’s gross-up is based on his W-4:

$220,000 salary and $20,000 taxable expense, and state of Illinois (flat 4.95% rate)

Single:

• 35% Federal + 4.95% IL + 2.35% = 42.3%

• Gross-up on gross-up percentage is 42.3/57.7 = 73.310%

• Gross-up is $14,662.05

Here’s what it looks like when Bill’s gross-up is based on his actual tax filing status:

Married filing jointly:

• 24% Federal + 4.95% IL + 2.35% = 31.3%

• Gross-up on gross-up percentage is 31.3/68.7 = 45.560%

• Gross-up is $9,112.08

3) Consider your options

In the example, Bill’s company used a marginal gross-up with an inverse rate. Here are the four options for a gross-up strategy:

• Supplemental gross-up with a non-inverse calculation: Calculates transferees’ gross-up at the flat rate of 22%. This method using a non-inverse calculation with a flat rate of 22% only tax protects the transferee on their taxable expenses. The additional taxes owed on the gross-up included in their income are the responsibility of the transferee.

• Supplemental gross-up with an inverse rate calculation: Calculates employees at the same flat rate of 22%, but considers the tax on tax gross-up for a more accurate calculation. This method using an inverse calculation with a flat rate of 22% protects the transferee on their taxable expenses and for the additional tax gross-up added to their income.

• Marginal gross-up with a non-inverse calculation: Calculates each transferee’s gross-up based on their individual tax bracket based on their filing status and earned income. The rates range between 10% and 37%. This method using a non-inverse calculation with marginal tax rates only tax protects the transferee on their taxable expenses. The additional taxes owed on the gross-up included in their income are the responsibility of the transferee.

• Marginal gross-up with an inverse rate: Calculates each transferee’s gross-up based on their individual tax bracket but considers the tax on tax gross-up for the most accurate calculation. This method using an inverse calculation with marginal tax rates protects the transferee on their taxable expenses and for the additional tax gross-up added to their income.

Many employers are drawn to the supplemental approach because it’s the easiest to administer and the simplest to explain. However, in most cases, we recommend the latter – marginal gross-up with an inverse rate. It is based on the employee’s actual tax situation and takes into account various factors, including filing status and earned income. It also accounts for the additional tax liability the gross-up creates – in other words, the tax on tax exposure.

4) Factor in stimulus checks when necessary

If you have transferees who received stimulus checks as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, keep in mind that the stimulus checks are considered advanced payments and some assignees may receive a credit on their 2020 tax filings.

Example: Let’s say an assignee’s 2019 (or 2018) income exceeded the stimulus threshold, but the following filing year, they are under the threshold. In this instance, the assignee will receive a tax credit – on their 2020 tax filing – that is equal to the stimulus amount they would have received if they had qualified on their 2019 (or 2018) filing.

If there’s a question, don’t hesitate to audit. You’ll need to see the actual returns to determine if the relocation caused a reduction in payment or if it was phased out for other reasons. As mentioned, some assignees may be eligible for a 2020 tax credit, so run what-if situations too. The best tax decisions are based on data.

Need help? We are here for you. Orion Mobility provides gross-up services to ensure you meet filing deadlines using the best gross-up approach for your employees and your company.

Contact us to learn more.