If you’re new to the world of corporate relocation or have become a little rusty, the term “relocation tax gross ups” may be confusing. No worries! You don’t need to be a CPA to understand how relocation taxes work. In the five minutes it takes to read this primer, you can master the basics every HR and recruiting pro should know.
First things first —
Relocation Taxes Have Changed
Until recently, corporate relocation expenses (for employers) and benefits (for employees) were treated differently under IRS tax code. In the good old days, relocation expenses were considered a deductible business expense for employers. Relocation benefits were not taxable to employees. But the Tax Cuts and Jobs Act of 2017 changed all that.
Although the new tax law benefited corporations in some ways, relocation program costs weren’t one of them. Effective January 1, 2018, the relocation expense deductions employers relied on—which applied to the transportation and storage of household goods as well as employee travel—were eliminated.
In addition, those same relocation expenses become taxable income for employees, so employees were penalized financially for accepting a relocation offer.
Overnight, corporate relocations became more expensive, for both employers and employees—hence the introduction of relocation tax gross ups.
How Relocation Taxes Work
Tax rates depend on a number of factors, including salary, filing status, location (both city and state), and a few others, all of which determine which tax bracket your employee falls into. This rate can range from anywhere between 10% - 40%. However, before you can understand how to gross up relocation taxes, you need to understand how relocation taxes work. Here’s two examples:
Example 1: Charlie’s Relocation Reimbursement
Charlie’s salary is $80,000. In an ordinary year, his W-2 would reflect $80,000 in earnings. However, Charlie relocated this year. His employer reimbursed him $2,000 for his U-Haul and $500 for a flight.
Therefore, Charlie’s W-2 will reflect $80,000 + $2,000 + $500, for a total of $82,500. Unfortunately, he must pay taxes on the additional $2,500. (Adding insult to injury, Charlie’s employer can no longer deduct that $2,500 as a business expense.)
Example 2: Lucy’s Traditional Relocation Package
Lucy’s employer has a different relocation policy. When Lucy—who also earns $80,000—relocated, her employer gave her a $5,000 relocation signing bonus and also paid a moving company $11,000 directly.
Therefore, Lucy’s W-2 will reflect $80,000 + $5,000 + $11,000, for a total of $96,000 earnings. She must pay taxes on that additional $16,000 in relocation benefits (ouch!). And no, her employer can’t deduct it.
As you can see, relocating has become an additional expense for employees, potentially souring them on the experience and discouraging future relocations. Employers who use relocation benefits as a hiring and staffing tool have a big problem. Enter relocation tax gross ups!
What is a ‘tax gross-up’?
If you’re not a tax expert (let’s be honest, neither are we!), you might ask the question, “what is a tax gross-up?” The definition of a tax gross up is when an employer increases the gross amount of a payment to take into account the taxes they would have to withhold from the payment. In order to keep employees happy and relocation programs working, most employers are choosing to “gross up” their relocation benefits to cover the employee’s tax obligation. This way, the employee is kept whole—no additional out-of-pocket expenses—and the relocation experience remains positive.
Think about it this way. When you give a relocating employee any sort of relocation benefit—whether it's in the form of a signing bonus, reimbursement for moving expenses, or even when you book a flight or pay for a service on behalf of your employee—that money and/or those services are considered taxable income.
It’s worth noting: even if you don’t give your employees cash, and pay for a service directly (think: moving company, a hotel stay, or a flight to the final destination) this is still considered taxable income to the employee. (US tax law still preserves the tax excludable status of corporate home sale programs, also known as BVO or GBO).
That means all relocation benefits, with the exception of corporate home sale programs, are subject to federal, state, and in some cases, local income taxes. With that said, grossing up relocation benefits is the best way to ensure you provide your employees with a great moving experience.
Let’s break this down again. Here’s how things would look for Lucy with and without a tax gross up:
Example 1: No Tax Gross Up for Lucy
Although Lucy received a $5,000 relocation bonus, $2,000 in income taxes are taken out before she gets the cash. In addition, based on the $11,000 moving costs her employer paid directly, she owes an extra $3,500 in income tax. Her W-2 will reflect $96,000 in earnings—and her relocation will cost her an extra $5,500 in income taxes.
Example 2: Lucy Gets a Tax Gross Up
In order to cover the taxes for Lucy’s $5,000 relocation bonus and $11,000 professional moving company, Lucy’s employer pays Lucy an additional $7,000 in earnings, paid directly to the IRS on Lucy’s behalf. The $7,000 includes the extra $5,500 tax burden, plus $1,500 for taxes on those dollars. Lucy’s W-2 will reflect $103,000 in earnings ($80,000 + $5,000 + $11,000 + $7,000), but her relocation won’t cost her a penny more in taxes.
Relocation Tax Recommendations for Employers
For employers who depend on their relocation program to acquire and retain top talent, a relocation tax gross up is the number one way to avoid a negative employee experience.
To report relocation benefits properly to the IRS, employers need to track relocation expenses meticulously. The best way to do so is to rely on a third-party relocation management company (or one of their partners) who specializes in this. Managing reimbursements, cash payments and/or direct payments to vendors gets tricky. If a payroll department fails to code these as taxable benefits, employers risk IRS fines and penalties.
What about the additional expense associated with relocation tax gross ups?
These days, smart employers are restructuring their relocation programs to be more cost-effective, using a number of different relocation strategies. In brief, these may include:
- Providing managed lump sum plans, which allow employees to use the funds at their discretion, so dollars go further.
- Offering tiered relocation packages, so employers can scale benefits to different level employees.
- Creating “Discard and Donate” incentives, which cut moving costs by incentivizing employees to donate their household goods to charity rather than move them.
More Questions You Might Have About Relocation Tax Gross Ups
Now, you’re up to speed on relocation tax gross ups—and then some. But just in case, here are some of the most frequently asked questions about relocation taxes and tax gross-ups:
1. I still don’t get it! What is a tax gross up?
In order to compensate for the tax ramifications of a relocation benefit, companies choose to ‘gross-up’ their relocation benefits. This means, in addition to the overall gross cost of the relocation benefit, the company also covers the cost of the tax liability to the employee.
2. Why should a company gross up employee relocation benefits?
Grossing up is a much better experience for the employee!
3. Do companies have to gross up employee relocation benefits?
No! While it is recommended to ensure the best employee experience, grossing up on relocation benefits is not required. If your company chooses not to gross-up on relocation benefits, it’s very important that you communicate the tax ramifications to your relocating employee—before they accept the offer to move. This is important, so that your employee is not blindsided come tax season.
4. If a company pays for moving expenses on behalf of the employee, are those expenses still considered taxable?
Yes! It is a common misconception that only lump sums (aka cash) are considered taxable income. All relocation benefits, no matter how they are paid (reimbursed, cash disbursement, direct billed) are considered taxable income with the exception of some corporate real estate programs. Even if the company pays for a moving company or hotel on the employee’s behalf, this is still considered income to the employee, and therefore, taxable.
5. If a company reimburses employees for their moving expenses are those expenses still considered taxable?
Yes! The reimbursement of relocation expenses are still considered taxable income to the employee. If your company has an expense reimbursement program in place to cover relocation expenses, you must decide whether those expenses will be grossed up.
6. Are relocation lump sums considered taxable income?
Yes. Lump sums, also called cash or relocation bonuses, are considered taxable income to the employee. If the company does not gross up the total dollar amount, taxes must be withheld from the gross amount.