Are Relocation Expenses for Employees Taxable When Paid by an Employer?
The short answer is “yes”. Relocation expenses for employees paid by an employer (aside from BVO/GBO homesale programs) are all considered taxable income to the employee by the IRS and state authorities (and by local governments that levy an income tax). This includes household goods transportation, temporary living expenses, miscellaneous allowances, lump sum payments and more.
Before Congress enacted the Tax Cuts and Jobs Act of 2017, the IRS permitted taxpayers to deduct certain moving expenses and exclude employer reimbursements for qualified moving expenses. These deductions and exclusions are no longer permitted, except for active duty armed forces personnel. This legislation took effect for the 2017 tax year and is scheduled to sunset in 2026.
The Impact on a Relocating Employee
The specific tax impact on a relocating employee is a function of his or her tax bracket and place of residence, but the amount an employer pays in relocation expenses, whether directly on or the employee’s behalf, is added to the employee’s W-2 for the year.
Here’s an example. Erica currently works for Blue Sky Company in Cleveland and earns $75,000 per year. She has accepted a different position with the company in Dallas at the same $75,000 salary. While she is not getting a raise, her employer gave her a $5000 bonus and a $10,000 lump sum to defray her moving costs. Erica’s W-2 income for the year would be $90,000 ($75,000 salary, plus bonus and lump sum.) She would owe Federal, state (and sometimes local) taxes on the bonus and lump sum as ordinary income.
Obviously, this is not a formula for happy employees! The relocation assistance and bonus Erica was expecting turns out to be much less than she expected (and perhaps negotiated). To help persuade employees to relocate and create a more satisfactory relocation experience, most employers “gross-up” the relocation benefits they offer to employees to offset the additional tax due.
What is Tax Gross-Up?
Gross-up is an additional payment from the employer to cover the extra taxes due on the relocation benefits. This process ensures that the employee gets the full, expected relocation benefit. Here is an illustration of the impact of tax gross-up:
Without Gross-Up
Erica is set to receive a $5000 bonus and a $10,000 lump sum towards her moving costs. Erica’s employer withholds Federal, state and local taxes as applicable from her payments. Instead of $15,000, Erica receives only about $10,500 in total.
With Gross-Up
Erica is set to receive a $5000 bonus and a $10,000 lump sum towards her moving costs. Erica’s employer pays an additional $5500 to the IRS on Erica’s behalf. This $5500 consists of the $4500 tax due on Erica’s relocation benefits, plus the “tax on tax” of the gross-up benefit. Erica receives the full $15,000 she is expecting, with the taxes already covered by her employer.
Are Employers Required to Gross-Up?
Gross-up payments can be one of the employer’s largest relocation expenses. While it is considered typical and best practice, employers are not obliged to gross up relocation benefits. Some employers compromise and gross-up only some relocation benefits.
Employers that choose not to gross-up should be sure that employees are aware that taxes will be withheld from the payments they are expecting. If the employer makes payments on the employee’s behalf, such as paying a moving company directly, the employee might have additional taxes due at tax time.
Gross-Up Rate/Calculation
Companies that choose to gross-up need to determine the rate they wish to apply. The options include:
- Flat rate: the company sets a universal rate and applies it to all gross-up calculations.
- Supplemental rate: a more precise rate based on actual withholding rates of Federal, state and local governments.
- Marginal rate: a more employee-specific rate that considers the employee’s income and filing status.
With the rate determined, the company then must determine a gross-up calculation method. Gross-up payments themselves are taxable, so companies need to decide if they will gross-up the gross up. There are at least three different ways for companies to calculate a gross-up: flat method, inverse method and true-up method.
- The flat method uses the flat, supplemental or marginal tax rate and does not attempt to reimburse the additional gross-up (tax on tax) amount.
In our example above, imagine the company applies a 25% flat gross-up rate. In this case, Erica would receive $15,000 and the employer would pay $3750 in taxes on her behalf. Because this is an estimated amount, Erica might still have taxes due at tax time, but it will be a lower amount. There is no attempt here by the employer to cover the tax-on-tax.
- The inverse method accounts for the additional gross-up amount in calculating the reimbursement. The calculation is: tax rate / (1-tax rate).
In our example above, imagine the combined Federal, state and local tax rate is 32%. In this case, Erica would receive $15,000 and the employer would pay $7050 in taxes on her behalf (.32 / (1 – .32) = .47 tax rate). Again, because this is an estimated amount, Erica might still have taxes due at tax time, but it will be a lower amount.
- The true-up method involves calculating the gross-up amount at the time of the relocation expense and again at year-end, before W-2 earnings are reported.
Any of these approaches will reduce the employee’s tax liability and increase his or her relocation benefit, but the tax burden does not go away: it shifts to the employer. Still, gross up is considered a relocation best practice. Your relocation management company can help you to determine the best approach for your company.
This information on relocation expenses for employees and the examples are provided as general information. Consult with your tax advisors for specific advice.
Want to know more about Employer and Transferee Taxation of Relocation Expenses?
Relocation Tax and the Mobile Workforce will cover:
- Relocation Tax Best Practices
- Tax Guidelines for Homesale Assistance benefit
- Relocation Policy components and Taxability