What is Gross-Up
Gross-up refers to increasing the gross amount of a payment to account for deductions, such as taxes. For example, Company ABC promises its employee a specific net amount. To ensure the employee nets the guaranteed amount, Company ABC increases the employee's wages to a specific gross amount to account for tax withholding.
BREAKING DOWN Gross-Up
Grossing up is usually done for one-time payments such as reimbursements for relocations expenses or bonuses. Depending on a company's calculation method, an employee may have an additional tax liability.
The Gross-Up Effect
Grossing up is mostly a matter of semantics. It merely restates an employee's salary as the take-home pay rather than gross pay before tax withholdings. Consider an employer offering an employee, who has an income tax rate of 20%, a net salary of $100,000 annually. The employer must gross-up the wage to $125,000 to account for the required 20% tax withholding. Some companies prefer the gross-up method, especially when compensating C-level executives and other high-paid employees. The technique can partially conceal salary expenses during financial reporting.
With executive pay coming under scrutiny in light of the 2008 financial crisis, grossing up has grown as an increasingly popular way to pay executives. Companies can efficiently increase executive pay by 30% or more, without it being apparent in their financial statements since those statements show only what employees net.
Several companies have made headlines for employing gross-up tactics with egregious and controversial results. In 2005, consulting firm Towers Perrin conducted a study revealing that 77% of companies, when changing management, grossed up severance packages for outgoing executives. One such company was Gillette, purchased by Procter & Gamble in 2005. Gillette's departing chief executive officer (CEO), James Kilts, received $13 million in gross-up payments in his severance package.