Grossing up, also known as a “net-to-gross calculation,” is typically used to ensure an employee receives a specific amount of money for special, one-time payments such as bonuses or moving costs. When an employee receives extra wages of this type, also called supplemental wages, the IRS considers them income, and they are therefore subject to taxes. Employers sometimes choose to add a gross-up amount to the employee’s payment to cover the income taxes the recipient will owe.

How It Differs from Standard Payroll

When calculating take-home pay for your employees under a standard payroll process, you start with their gross salary, withhold payroll taxes, and then write a check for the resulting net pay amount.

As you might guess, grossing up takes the opposite approach. You first determine what you want your employee’s net pay to be, which is the actual dollar amount the employee takes home, and then you work backward to figure out the gross pay needed.

To better understand how a gross-up calculation can work for a company’s small business payroll, let’s look at a common use case.

The Gross-Up Concept and Calculation

What is the Gross-Up Rule?

The “gross-up” rule is a practice where an employer increases the gross amount of a payment to cover the income taxes that the recipient will owe on that payment. This guarantees that the employee receives a specific net dollar amount after taxes are withheld. One-time payments such as bonuses, relocation expenses, or other taxable fringe benefits are common scenarios where gross-ups are applied.

While a specific “IRS gross-up rule” does not formally exist, the concept of tax gross-up is a general practice recognized in the context of fringe benefits and one-time payments.

How Do You Calculate a Gross-Up?

To understand the calculation, it is helpful to treat it as a math equation using the following formula:

Gross Pay = Net Pay ÷ (1 − Total Tax Rate)

Let’s use this 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. The “Tax Rate” in the equation is the sum of all the necessary tax rates, which may include:

Supplemental federal income tax rate (federally set at 22%)
Social Security: 6.2%
Medicare: 1.45%
California supplemental state withholding: 10.23%
California SDI: 1.3%

When we add these rates together in this example, the total estimated tax rate becomes 40.98%. We will use this rate as a decimal in the equation, which equals 0.4098. That means a California gross-up example will generally require a higher gross payment than a similar example in many other states because California includes both supplemental state income tax withholding and SDI.

1 — Subtract the tax rate from 1.

2 — Divide the desired net pay ($700) by the resulting value.

3 — Verify the withholding amount and resulting net pay.

This process helps determine the gross amount that must be paid so the employee ultimately receives the desired take-home pay after all required taxes are withheld.

Common Scenarios for Net-to-Gross Pay

Now that we’ve covered the math, let’s discuss some examples of when an employer may decide to use a gross-up.

Incentives for New Hires

Bonus pay can help a new hire feel confident that joining your team is the right move. Employers should remember that this type of supplemental wage is subject to federal and state withholding. Using a gross-up, which covers the taxes the new employee will owe, is a way to ensure the staff member receives the full dollar value of the bonus.

Why use a gross-up here? A top recruit may not fully understand the tax implications of perks like supplemental wages and may simply expect to receive the total promised bonus amount. To build goodwill and avoid confusion, grossing up a bonus can go a long way toward keeping the newest member of your team happy.

Commission-Based Pay

Many salespeople know they are due a pay increase when they hit a sales quota. However, seeing what their actual take-home pay is once taxes are withheld can be an unpleasant surprise.

For businesses that rely on sales professionals, a gross-up can be used to ensure that employees receive the full commission amount after taxes and other deductions are factored in.

Why use a gross-up here? 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.

Relocation Expenses

Are you hiring an employee who has agreed to relocate? They will almost certainly incur expenses. A gross-up can make a big difference in helping to offset moving expenses.

Why use a gross-up here? It is 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.

Grossing Up Relocation Example

Let’s say your small business wants to hire Judith, who must relocate to take the position. To help with the move, you offer a one-time signing bonus to cover her $5,000 moving expenses.

That $5,000 payment is technically taxable as a fringe benefit. If you simply pay Judith a $5,000 bonus, she may receive significantly less after taxes are withheld.

To solve this issue, employers often gross up the payment. By working backward from the desired net amount, the company can determine the gross amount required so the employee still receives the full $5,000 needed for moving expenses.

As a result, Judith receives the full amount she needs to cover her relocation costs, while the employer ensures all required taxes are properly accounted for.

If crunching all the numbers becomes too complicated, many employers turn to payroll software to handle the calculations automatically. Payroll systems can apply federal, FICA, California PIT, and California SDI rules while reducing the risk of costly errors. The Beyond HCM platform helps simplify these types of payroll calculations so business owners can focus on running their companies.

Final Considerations for Grossing Up

Remember that employers are responsible for payroll taxes on any supplemental income employees receive. This can include federal unemployment taxes, state unemployment taxes where applicable, employer contributions to Social Security and Medicare, and employee-side withholding obligations that affect the final net amount.

Drawbacks of Mishandling Grossing Up

If a gross-up is not calculated correctly, it can have the opposite impact, causing frustration instead of goodwill and often creating extra work for everyone involved. Potential issues include:

– Extra work for your accounting or payroll department to correct mistakes.
– Increased tax liability for the employee receiving the payment.
– The need to amend tax filings if incorrect payroll reporting occurs.

In rare cases, incorrect payroll reporting could even lead to audits or compliance issues.

Get Grossing Up Right

Grossing up a payment, whether calculated manually or with a net-to-gross calculator, helps ensure employees receive a specific after-tax amount for special payments such as bonuses, commissions, or relocation reimbursements. By accounting for federal income tax obligations, FICA taxes, California supplemental withholding rules, and California SDI, employers can help ensure that staff members receive the intended value of their payment while keeping payroll calculations accurate.

This calculator is designed to provide a helpful estimate for California payroll scenarios. Actual payroll results may vary depending on an employee’s withholding elections, year-to-date wages, the type of supplemental payment, and how the payment is processed. If you need help reviewing a gross-up payment or managing payroll calculations, the Beyond HCM team is always available to assist.