Updated: June 28, 2023
Why use a gross-up?
Grossing up (also known as a “net-to-gross calculation”) is generally used to ensure a staffer receives a specific amount of money for special one-time payments like bonuses or moving costs. When an employee receives extra wages of this type (also known as supplemental wages), they’re considered income in the eyes of the IRS, and subject to taxes. Employers sometimes add a gross-up to an employee’s wages to cover the income taxes the recipient will owe.
How is this different from your standard payroll obligations? When calculating take-home pay for your employees, you take their gross salary (which consists of all the money they’ve earned), then withhold their payroll taxes and write a check for the resulting net pay amount. This sounds pretty standard and familiar, right?
As you probably guessed, grossing up takes the opposite approach. After you determine what you want your employee’s net pay to be (this is the actual dollar amount the employee would take home), you work your way backward to figure out the gross pay.
To better understand how a gross-up calculation can work for a small business, let’s look at a fairly common use case.
How do you calculate a gross-up?
To understand how a gross-up is calculated, it might be helpful to treat it as a math equation using the formula below:
Gross-up amount = desired net pay / (1 – Tax Rate)
Let’s use it to gross up a $700 bonus.
In the equation above, the desired net pay is the amount of take-home pay an employer wants the employee to receive after taxes are withheld. And the “tax rate” in the equation is the sum of all the necessary tax rates, so you’ll need to include:
- Supplemental tax rate, which is set federally at 22%
- Social Security: 6.2%
- Medicare: 1.45%
When we add the rates up, it comes out to 29.65% (but you’ll want to use the rate as a decimal in the equation, so let’s make that .2965).
Next, we’ll subtract the tax rate from 1:
1 minus .2965 = 0.7035
- Then we’ll divide the net pay ($700) by the rate (0.7035)
- $700 divided by 0.7035 is: $995.00 (this number totals the gross payment)
- $995 x .2965 is: $295.00 (this number equals the total tax withheld)
- $995 – $295 = $700 (this is the net bonus the employee should receive)
So the gross-up (or extra pay the employer pays to ensure the employee gets to the desired net pay) is: $295.
Now that we’ve covered the math involved in a gross-up, let’s discuss some examples of when an employer may decide to use one.
Common gross-up scenarios
Incentives for new hires
Bonus pay can help a new hire feel even more confident that choosing to join your team is the right move. That said, employers should remember that this type of supplemental wage is subject to federal income tax — and Uncle Sam expects to get his due. So, using a gross-up (which accounts for the income taxes the new employee will owe), is a way to ensure a staffer receives the full dollar value of the bonus.
Why use a gross-up here?
The top recruit you convince to come on board may not fully understand the tax implications of perks such as supplemental wages (and just expect to receive the total bonus amount). So to build good will, and avoid confusion, grossing up a bonus can go a long way toward keeping the newest member of your team happy and ready to contribute.
Many salespeople know they’re due for a well-deserved pay bump when hitting (or exceeding) a sales quota. However, once the new deals they’ve closed have come and gone, it can be eye-opening to see what take-home pay actually adds up to once taxes are withheld.
For businesses that count on sales professionals, a gross-up can be used to ensure that employees receive the full amount of the commission after taxes and other deductions are taken into account.
Why use a gross-up here?
Some businesses rely on salespeople to reel in the lion’s share of revenue. By using a gross-up to account for taxes, sales teams will appreciate that their employer is going the extra mile to make sure they receive the full value of their commissions (which can help teams stay motivated to close more deals).
Are you hiring an employee in another state who’s agreed to relocate to your neck of the woods? They will almost certainly incur some expenses in order to relocate closer to where you do business. A gross-up can make a big difference in helping to offset moving expenses.
Why use a gross-up here?
It can be a good way to start the employer/employee relationship off on a positive note. Using a gross-up to cover costs and help with the tax obligations related to the move is another way to show appreciation for a new hire making the trek to join your team.
Now that we’ve discussed some common scenarios in which employers may use gross-up pay, let’s take a closer look at the relocation example.
Grossing up relocation example
Let’s say your small business is located in Southern California, and you really want to hire Judith, who lives in Northern California. To get her to take the job, you offer to pay a one-time signing bonus to cover her $5000 moving expenses as an incentive for joining your company.
That $5,000 bonus is technically taxable as a fringe benefit, so paying Judith a gross wage of $5,000 means she only takes home $3,750 after her 25% income tax rate is applied. Meanwhile, she still has to pay her movers $5,000, so she would be short $1,250.
To remedy the situation (and help Judith feel even better about joining your company), you can gross up her bonus check. To do this, you work backward to come up with the gross-to-net pay calculation and divide $5,000 by 75%. As a result, Judith’s gross signing bonus comes out to $6,666.67. Judith is happy because she receives the full $5,000 to pay her movers. You’re happy because you’ve convinced Judith, who was the top candidate during the interview process, to join your small business.
Drawbacks of mishandling grossing up
If a gross-up is not calculated correctly, it can have the opposite impact — causing heartache instead of goodwill and often triggering extra work for everyone involved. That means its critical to ensure your gross-up calculations are spot on. The negative consequences of miscalculating include:
- Causing extra work for your accounting or payroll department to recalculate and correct the error.
- Increased taxes for the employee who received the extra pay, which can diminish morale and impact their desire to remain with the company.
- The need to amend tax returns on the employee’s part when an incorrect W-2 is involved in the error
- In the worst case scenario, the incorrect gross-up calculation could result in an IRS audit for the company, the employee who received the supplemental pay, or both.
Other useful paycheck calculators
The calculator at the top of the page can help you get gross-up pay right for you and your employee. However, there may be situations when paychecks need a bit more wrangling. For instance, when an employee decides to leave, you may need to issue a final paycheck. Or, if you offer tipped wages or bonuses, you may need to add another step or two to your gross pay formulas for hourly and salaried employees. That’s why we designed a set of calculators that you can use any time of day or night (and help keep the math from getting too complicated).