Tax gross-up: Overview, definition, and example
What is tax gross-up?
Tax gross-up refers to an arrangement in which one party agrees to cover the tax liabilities of another party so that the recipient receives the full intended amount after taxes. This is commonly used in employment contracts, financial transactions, and cross-border payments to ensure that tax deductions do not reduce the net amount received. The gross-up amount is calculated by factoring in applicable taxes and adjusting the payment accordingly.
For example, if an employer agrees to pay an employee a $10,000 bonus but wants the employee to receive the full amount after taxes, the employer will calculate and pay additional funds to cover the required tax withholding.
Why is tax gross-up important?
Tax gross-up is important because it ensures that the recipient of a payment is not financially disadvantaged due to tax obligations. It is particularly useful in international transactions, expatriate employment contracts, and indemnification agreements where tax implications vary based on jurisdiction. By including a gross-up provision, parties can ensure fair compensation and avoid unintended financial burdens.
For businesses, tax gross-ups help attract talent, facilitate international operations, and provide financial clarity in contracts. For employees and service providers, a tax gross-up guarantees that they receive the agreed-upon amount without reductions due to tax withholding.
Understanding tax gross-up through an example
Imagine a multinational company sending an executive to work in another country. The executive's salary is subject to local income tax, but the company agrees to a tax gross-up to cover these taxes. If the executive’s salary is $100,000 and the tax rate in the foreign country is 30%, the company calculates the gross-up and pays additional compensation so that the executive still takes home $100,000 after taxes.
In another example, a company issuing dividends to foreign investors may agree to a tax gross-up to offset withholding taxes imposed by the investor’s home country, ensuring that the investor receives the full intended dividend amount.
Example of a tax gross-up clause
“If any payment under this Agreement is subject to deduction or withholding for taxes, the paying Party shall increase the payment by an amount necessary to ensure that the receiving Party receives the full amount as originally intended, net of any tax withholding. The Parties agree to cooperate in obtaining any available exemptions or reductions to minimize tax liability.”
Conclusion
Tax gross-up is a valuable contractual mechanism that ensures a recipient receives a full payment amount despite tax obligations. It is widely used in employment agreements, cross-border transactions, and financial contracts to account for tax deductions and provide fair compensation. Including a tax gross-up clause in agreements helps clarify tax responsibilities, reduces financial uncertainty, and ensures compliance with tax regulations while protecting the interests of all parties involved.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.