Relocation expense reimbursement, lump sums, and bonuses are often offered as part of employee relocation packages to cover the employee's costs of moving to the new location. Getting relocation expenses paid for is a welcome benefit for employees moving for work. It allows them to focus their attention on hitting the ground running in the new city and start producing more quickly. However, there are often tax implications that companies don't consider. Therefore it's essential to understand the tax differences between relocation related expenses and employee salary bonuses.
For the employee, both bonuses and employer-paid moving expenses, such as moving company service expenses, are considered taxable income by the IRS (except for tax safe homesale assistance programs, more on this later). Since most relocation benefits are considered taxable income, this requires employers to pay standard payroll taxes such as Federal, State, and FICA. If the company forgets to factor in tax implications from relocating an employee, it could cause big problems. Both the employee and company could experience a costly and time-consuming mess come tax season thanks to our friends at the IRS. But don't worry! We are here to help. Keep reading to learn different approaches to address these concerns in a streamlined, efficient, and most importantly, tax-compliant way.
Are Relocation Lump Sum Packages Taxable Income?
The short answer is yes.
In a lump sum relocation program, the employee is responsible for paying taxes on the lump sum payment. The IRS views this lump sum benefit as the same as a salary bonus.
Does the company or
the employee pay the taxes on a Lump Sum relocation package?
What options are available to pay the taxes on a lump sum?
There are two primary ways that companies treat taxes when it comes to lump sum benefits when moving an employee. First, we'll talk about…
Employee Paid Lump Sum Taxes
The company can choose to allow the employee
to pay the taxes from the lump sum expense. They usually would pay the taxes
themselves just like they would with an employer bonus. Having the employee pay
for the taxes on the lump sum might save the company some money in the short-term
but in general unecessarily burdens the employee and might lead to issues down the road. For this reason, having the employee pay for the lump sum taxes is not considered
best practice by industry experts.
Why is it a bad idea to make the employee responsible for paying taxes on the relocation lump sum?
It's a bad idea to make the employee responsible for paying the lump sum's taxes because the lump sum is intended to cover reasonable expenses for a move, for work. It should not be treated as a bonus or a reward from the employee's contributions to the company. Suppose the tax implications are not clearly communicated upfront to the employee by the organization or your relocation management company. In that case, the employee may feel like they lost money when taxes come due during tax filing season. Furthermore, they may have spent the full amount of the lump sum (or likely more) just on moving expenses believing they received more money than they did. It is not uncommon for employees to rack up considerable credit card debt when relocating for work when the relocation is not managed in a professional way. This lack of planning for the employee causes stress on job performance. Even worse, the employee might be knocking on their boss' or HR's doors asking for more money months after the move is completed. Imagine how awkward and embarrassing this might be for an employee who recently joined the new office team. Keep reading to learn how to avoid these mistakes...
How much of my
employee's personal taxes will be affected by a relocation lump sum?
The short answer is that it depends, again. This largely depends on the employees personal Federal and State tax rates.
Employee Relocation Lump Sum without Taxes Paid Example
Suppose the company gives an employee a relocation lump sum without paying the taxes (without tax "gross-up"). In that case, it could look like the below example.
For example, the company has authorized an employee to receive a $5,000 relocation lump-sum bonus without any tax assistance. How would the IRS treat this money? As mentioned above, the IRS would treat this lump sum as a bonus that would be fully taxable for the employee. For this example, let's say the employee's Federal, State, and FICA effective tax rate is 33%. In this case, the employee would need to be responsible to pay $1,650 in taxes on this lump sum, netting the employee only $3,350 total from the $5,000 employee relocation lump sum.
Since it is prevalent for both companies and employees to underestimate the relocation costs and overestimate how far they will stretch that lump sum amount it is recommended to take a different course of action. Most relocation management companies would recommend getting ahead of this by creating a policy and program that maximizes the IRS's tax benefits for relocation. (Based on current tax law, this means offering a homesale assistance benefit, which allows for certain expenses to not be counted against the employee as income.) When lump sums are offered, they should be grossed up to improve the employee experience and make things easier on the whole organization.
Employer Paid Lump Sum Taxes
How can I pay for my employee's relocation lump sum taxes?
The short answer is something referred to in the relocation and tax world as "Tax Gross-Up."
What is relocation tax gross-up?
Investopedia.com puts it simply:
- A gross-up is an additional amount of money added to a payment to cover the income taxes the recipient will owe on the payment.
- Grossing up is most often done for one-time payments, such as reimbursements for relocation expenses or bonuses.
How does a company pay the employee's taxes for a relocation lump sum?
The short answer is, it's complicated but important. (This is why it is recommended to work with a good relocation management company, like Paragon, to maximize the employee and company's tax benefits while reducing risk.)
To pay the taxes for an employee when they receive a lump sum, the company will need to gross up the money received. How does this work? The tax gross-up methodology depends on the company's philosophy and approach. The organization needs to decide what gross-up rate methodology they will use, and then implement it systematically for all relocating employees.
Most common ways to pay for employee taxes as a result of a relocation:
- The Flat Method sets a flat tax percent amount to be paid over and above what the employee receives. For example, the company chooses to give the employee $3,000 as a lump sum but wants to assist the employee with the taxes by giving them 25% more. The company's total would be $3,000 plus 25% ($750), equating to $3,750 total received by the employee. This wouldn't always provide a dollar for dollar reimbursement on the taxes but would provide the employee some help and be simple to calculate for the organization.
- The Inverse Method considers the employees existing taxes. It provides a custom-tailored tax gross-up so that each employee receives the full amount of their relocation lump sum. Because the IRS considers the additional gross-up amount as income, you have to pay more gross-up to cover the gross-up. The IRS almost always finds a way to get paid! Covering the taxes on the gross-up amount is referred to as paying for the "tax-on-tax" liability. The formula to calculate the inverse gross-up method is: Tax Rate / (1–Tax Rate) = Inverse Gross-Up Rate.
Most organizations that use the inverse method work with a Relocation Management Company with technology and staff dedicated to making this process seamless and easy for an overall well-run relocation program.
The company can choose to burden the employee to pay the taxes from the lump sum expense. They usually would pay the taxes themselves just like they would with an employer bonus. Having the employee pay for the taxes on the lump sum might save the company some money in the short-term but might lead to issues down the road. Thus, industry experts consider it best practice to cover the employee taxes when being moved for work. Furthermore, the company should also take advantage of the tax benefits of an IRS compliant homesale assistance program such as the Buyer Value Option and Guaranteed Buyout. These programs are a great way to increase an employee acceptance rate, improve the relocation experience, and from a tax perspective, help maximize tax benefits.
Do you need help relocating employees? Are you concerned about employee experience and tax liabilities?
Contact Paragon Relocation today for a no-obligation relocation program analysis and hear about how we have successfully reduced tax risk while improving employee experience for over 30 years.
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