What is 'Gross Up'
Gross up usually refers to an employer reimbursing workers for the taxes paid on some portion of their income, usually from a one-time payment such as relocation expenses. In other words, if an employee is promised $5,000 for relocation expenses, the actual check might be issued for $6,500. This would leave the promised $5,000 after deducting the required taxes.
BREAKING DOWN 'Gross Up'Grossing up can be one of those gifts that comes back to haunt the recipient. Depending on how a company calculates the gross up, an employee may still end up owing money at tax time. To ensure that there are no surprises for the employee, the employer should use a tax professional to account for all the employee's income and deductions for the entire year, not just the amount of the check being grossed up.
The Gross-Up Effect
Grossing up is largely a matter of semantics. It simply restates an employee's stated salary as his take-home pay rather than his gross pay prior to taxes being deducted. For example, if a company promises an employee $100,000 per year and the employee's effective tax rate is 20%, and the employer wants to ensure that the worker takes home the full $100,000 after taxes, the company might gross up the employee's pay to $125,000. This way, the employee takes home $100,000 after forfeiting 20% to taxes.
The employer could accomplish the same purpose by simply offering a salary of $125,000. Many companies, however, prefer the gross-up method, particularly when compensating C-level executives and other high-paid employees, as it can partially obscure in financial statements just how much money such employees are being paid.
With runaway executive pay coming under scrutiny in light of the 2008 financial crisis, the practice of grossing up has gained in popularity. Using this method, companies can effectively increase executive pay by 30% or more without it being obvious in their financial statements. The financial statements show only what the employees take home (for instance, the employee's pay in the example above would be stated at $100,000, not $125,000), and the practice of grossing up is explained in fine print that many investors fail to read.
Several companies have made headlines for employing gross-up tactics with egregious and controversial results. In 2005, consulting firm Towers Perrin conducted a study which revealed that 77% of companies, when changing management, grossed up severance packages for outgoing executives. One such company was Gillette, which was purchased by Procter & Gamble in 2005. Gillette's outgoing chief executive officer (CEO), James Kilts, received $13 million in gross-up payments on his severance package.