Gross-Up

A gross-up is an upward adjustment to a payment so the recipient ends up with a specific net amount after taxes or fees are taken out. Instead of the worker absorbing the deduction, the payer increases the payment to cover it. The mechanism is a general business and payroll practice rather than a defined term in any single statute, so the math below describes how it works in plain terms, and US payroll-tax figures are attributed to their source.

The Basic Mechanism

The wrong way to gross up is to add the tax amount on top of the net. That undershoots, because the amount you added is itself subject to the same deduction. The correct method divides the target net by one minus the applicable rate:

Grossed-up amount = Net target / (1 - rate)

Suppose you want a contractor or employee to receive a clean 2,000 dollars after a combined 30 percent deduction. Adding 30 percent of 2,000 (600 dollars) gives 2,600 dollars, but a 30 percent deduction on 2,600 dollars is 780 dollars, leaving only 1,820 dollars. The divide method gives 2,000 / 0.70, which is about 2,857.14 dollars. A 30 percent deduction on that figure is about 857.14 dollars, which leaves exactly 2,000 dollars. The larger the rate, the larger the gross-up, because more of each added dollar is consumed by the deduction.

Where Gross-Ups Come Up

Gross-ups appear wherever a payer commits to a net number rather than a gross one.

• Bonuses and relocation. An employer that promises a 5,000 dollar net relocation bonus grosses up the gross wage so withholding still leaves 5,000 dollars in the worker’s account.
• Sign-on and guaranteed take-home. A guaranteed net salary or sign-on payment is grossed up to absorb the worker’s withholding.
• Contractor fee arrangements. A client that agrees to cover a payment fee or a withholding amount grosses up the invoice so the contractor nets the quoted figure.

US Payroll-Tax Context

For US payroll run through an employer, a gross-up usually targets the federal supplemental withholding plus the worker’s FICA share and any state withholding. The IRS sets the flat federal withholding rate on supplemental wages at 22 percent, with 37 percent applying when supplemental wages paid to an employee exceed 1 million dollars in the calendar year, per Publication 15. Those are the deduction rates a payroll gross-up has to clear. FICA is 7.65 percent on the employee side, so a single combined rate folds both into the divide-by-one-minus-the-rate formula. Self-employed workers are not in payroll withholding at all, and instead owe self-employment tax, so a contractor gross-up is typically a private fee or net-pay agreement rather than a payroll calculation.

Common Pitfalls

• Adding instead of dividing. Tacking the tax on top of the net always falls short of the target.
• Using one rate when several apply. Federal supplemental, FICA, and state rates stack, so the gross-up has to use the full combined rate.
• Forgetting the gross-up is itself income. The extra amount is taxable wages and is reported as such.

Related Terms

• FICA: the payroll tax whose employee share a payroll gross-up often has to cover.
• Self-Employment Tax: what a self-employed recipient owes, which shapes a contractor-side gross-up.

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