Getting Gross-ups Right: Avoiding Common Mistakes in Executive Compensation

When structuring executive benefits such as housing allowances or tuition support, employers often aim to make these benefits "tax-neutral" for the recipient by providing a gross-up - a payment intended to cover the income taxes triggered by the benefit itself. But while the intention is to keep the executive whole, the math behind gross-ups is frequently applied incorrectly, and when it's done incorrectly, it almost always favors the employer, not the executive.

The Correct Gross-Up Formula

To fully offset the tax burden, the gross-up should be calculated using the formula:

Gross-Up = Benefit / (1 – t) – Benefit
where t = the executive’s combined marginal tax rate

For example, if an executive receives a taxable $90,000 housing allowance and their total marginal tax rate is 40%, the proper gross-up would be:

$90,000 / (1 – 0.40) – $90,000 = $150,000 - $90,000 = $60,000

So, the necessary gross-up payment would be $60,000, bringing the executive’s total pre-tax compensation, related to this benefit, to $150,000, of which only $90,000 is effectively received after tax. This method ensures that the taxes owed on the original benefit and on the gross-up itself are both covered.

Common Gross-Up Mistakes (And Why They Matter)
Despite being conceptually simple, gross-ups are frequently miscalculated, usually in ways that undercompensate the executive. Here are four of the most common mistakes:

1. Failing to Gross Up the Gross-Up
Many employers just reimburse the executive for the taxes paid on the original benefit - but forget that the gross-up payment is itself also taxable. This leads to a shortfall unless the formula accounts for the recursive tax hit. A “tax reimbursement” is not a true gross-up because it doesn’t address the taxes on itself. A true gross-up, as calculated above, does.

2. Using the Wrong Tax Rate

Some employers use:

• The executive’s effective tax rate instead of their marginal tax rate;

• A blanket assumed rate (e.g., 25% or 30%) that’s not tailored to the executive's actual situation;

• Or worse, an outdated or arbitrary guess.

High-earning executives may face marginal rates well over 40% (over 50% in some jurisdictions)  when all federal, state, and local taxes are considered—so using a lower assumed rate results in a significantly underfunded gross-up.

3. Ignoring the Full Tax Picture

It’s not enough to consider federal income tax alone. A proper gross-up must account for:

• State income taxes

• Local income taxes (where applicable)

• Medicare tax

• The Additional Medicare tax for high earners

Neglecting even one of these can leave the executive footing a substantial portion of the tax bill.

4. Any Combination of the Above

Often, multiple errors are baked into the same calculation, such as using an effective tax rate and excluding state taxes and skipping the gross-up on the gross-up. The result can be thousands of dollars in unintended tax cost to the executive, eroding the value of what was meant to be a tax-neutral benefit.

Why It Matters

For schools, nonprofits, and other mission-driven employers, providing gross-ups for certain benefits—such as taxable tuition remission or housing support—can be an important part of attracting and retaining top leadership talent. But a poorly calculated gross-up not only defeats the purpose but may cause frustration, mistrust, and unintended inequity.

The cost of getting the formula right is often marginal. The cost of getting it wrong, especially over multiple years, can be far greater.

Best Practices

• Use the correct formula: Benefit / (1 – t) – Benefit

• Verify and apply the executive’s actual combined marginal tax rate, including all applicable taxes

• Review all gross-up provisions annually, especially when tax laws change

• Consult with tax professionals who understand executive compensation

Conclusion

Gross-ups are a well-intentioned feature of executive compensation - but they’re only effective when calculated properly. A little extra diligence goes a long way in ensuring that the executive receives the intended value of the benefit and that the employer delivers on its promise of fair, equitable compensation.

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