Examining the Implications of "Grossing-Up" Employee Compensation

This might fall under the category of no-good deed goes unpunished. Next month, you will probably see us continue this series when we talk about giving employee gifts and hosting holiday parties.

In many organizations, bonuses are a key component of employee compensation, designed to reward performance, incentivize productivity, and retain talent. One practice that has emerged in the administration of bonuses is the "gross-up," where employers increase the bonus amount to “cover the taxes” (more on that in a moment) so that employees receive the intended net amount. While this may seem attractive on the surface, grossing up bonuses potentially introduces significant issues related to equity and organizational fairness.

What is Grossing-Up?

A gross-up bonus occurs when an employer calculates the bonus so that, after taxes are withheld, the employee receives a predetermined net amount. For example, if an employee is to receive a $5,000 bonus, and the tax rate is 30%, the employer may pay the employee $7,143 so that, after taxes, the employee still receives $5,000.

Sounds good, right?

Inequities Caused by Gross-Up Practices

Grossing up bonuses can create inequity among employees for several reasons:

• Disproportionate Benefit: Employees with higher tax rates will receive larger gross-up amounts, while those with lower tax rates will get less. This means that employees in higher tax brackets or with more deductions end up getting a more substantial gross bonus, more to get to the same net amount, which can be perceived as unfair by others. Keep in mind, the gross amount is what will show on the employee's W-2, so the employer is not necessarily covering all taxes associated with the bonus. And the gross amount bump could move the employee into a different income tax rate.
• Inconsistent Application: Gross-up policies are sometimes applied selectively, such as for certain incentive programs. This selective application can lead to resentment and reduce morale among employees who are excluded from gross-up benefits.
• Undermining Pay Equity: By manipulating bonus amounts to account for individual tax situations, employers may inadvertently undermine efforts to maintain pay equity. Employees, or even government enforcement agencies, may question why some receive higher gross bonuses than others for the same performance.
• Transparency Issues: Employees may not fully understand how their bonuses are calculated or why gross-up applies to some but not others. This lack of transparency can erode trust in the compensation system.

Other Organizational Impacts

Beyond equity concerns, grossing up bonuses presents several practical and ethical challenges:

• Administrative Complexity: Calculating grossed-up bonuses requires detailed knowledge of each employee’s tax situation, increasing administrative burden and the risk of errors. Mistakes can lead to compliance issues and employee dissatisfaction.
• Cost Implications: Organizations incur additional costs when grossing up bonuses. This may divert resources from other compensation programs or business priorities, leading to inefficiencies.
• Tax System Distortion: Gross-up practices can be seen as circumventing the intent of progressive tax systems, where higher earners pay more taxes. By offsetting tax liabilities, employers may inadvertently interfere with the existing tax framework.

Conclusion—Proceed with Caution

While grossing up bonuses may appear to be a generous gesture, it introduces possible inequities and complications within the workplace. The practice can result in unfair advantages for certain employees, administrative difficulties, increased costs, and a lack of transparency. Organizations seeking to maintain fairness and equity should carefully consider the drawbacks of grossing-up bonuses and other compensation and explore alternative, more equitable approaches to employee compensation.