What does the term "gross up" mean?
5 Answers
Garrick Saito,
Written 165w ago · Upvoted by Marie Stein, Former securities analyst at Fidelity Investments; FINRA arbitrator
Essentially, it means that an employer has agreed to pay income taxes for an employee.
An example: We used to have a CEO that used to like to give bonuses based upon what the employee took home. "Give that guy $5K." What he meant by that was "I want this employee to have $5K in his pocket when he goes home tonight." If the bonus was calculated on a gross earnings of $5K, federal and state income taxes, by law, would have to be deducted from the employee's bonus check resulting in (perhaps) a $4K take home amount. That is not what the CEO wanted. Therefore, we would have to "gross up" the employee's paycheck via a reverse payroll tax calculation so that the employee would be 'technically' paid (say) $6,500, minus state and federal taxes of $1,500, resulting in a net pay of $5K.
So even though the CEO said to pay him $5K, we really paid him $6.5K (because the company also paid the taxes on his behalf).
From Practical Law, a Thomson Reuters Legal Solution
Also known as grossing-up. Under a gross-up clause, a payor must pay an additional amount to a payee to ensure that the payee receives and retains the same amount that it would have received had no tax been withheld from, or otherwise due as a result of, the payment. Gross up clauses are typically included in a wide variety of transactions documents, including credit agreements, deal documents, employment agreements and swap documents.
For example, assume that the borrower in a loan agreement must pay $100 of interest to the lender but has to withhold tax at a 30% rate. In this case, the borrower will pay $70 to lender and $30 to the IRS. If the loan agreement includes a gross-up clause (which is customary), the borrower will have to pay the lender an additional sum so that the lender actually receives and retains $100. At first glance, that sum may seem to be $30. However, that $30 itself may be subject to withholding tax, in which case the borrower must pay $21 to the lender and $9 to the IRS. The borrower would then still be obliged to pay $9 to compensate the lender but again withholding might apply. If a withholding tax applies, the borrower must pay $6.30 to the lender and $2.70 to the IRS. This process continues until the lender receives and retains the same amount that it would have received had no tax been withheld from the payment ($100 in this example). This process is called grossing-up.
If the withholding tax rate is 30%, the gross-up formula to determine the aggregate amount to pay the payee is: (the dollar amount of interest owed x 100) ÷ 70. Therefore, in this example, the borrower must pay the lender $142.86 under the gross-up clause for every $100 of interest owed.
In the context of financial statement presentation, it refers to showing the gross amount of related types of transactions as separate items instead of adding them together as a single amount (netting them). Certain items are required to be shown "net" on the financial statements, such as the combined amount (or "position") of deferred tax assets (DTA) and liabilities (DTL).
That is, after adding together DTAs and DTLs, you'd have a combined amount that would either be in a "net" asset position or a "net" liability position, and would be reflected as such in its combined form on the balance sheet assets OR liabilities.
If you showed them separately in assets AND liabilities, then this is what is referred to as a balance-sheet "gross-up", because the result is that Total Assets and Total Liabilities would be higher than if you had combined the net amount into one single asset or liability position.
That is, after adding together DTAs and DTLs, you'd have a combined amount that would either be in a "net" asset position or a "net" liability position, and would be reflected as such in its combined form on the balance sheet assets OR liabilities.
If you showed them separately in assets AND liabilities, then this is what is referred to as a balance-sheet "gross-up", because the result is that Total Assets and Total Liabilities would be higher than if you had combined the net amount into one single asset or liability position.
The definition depends on which industry you're talking about. In commercial real estate, the term refers to the process of factoring in estimated or actual operating expenses to a net leased building. This allows tenants and landlords to be able to compare lease rates on a gross or full-service basis.
