How are grossed-up payments calculated?

In cases where you want to provide a payment to an employee that is equal to a specific amount of money, including awards or bonuses, you may pay the federal income tax and employee FICA (Social Security and Medicare) taxes due. However, those tax payments you make for an employee are also subject to withholding.

Basic formula. To compute the gross amount of a bonus payment when you want an employee to receive a specific amount of take-home pay, use the formula

X = Y + WX + FX

The formula takes two factors into account-the tax that you will absorb based on the net amount of the bonus, and the pyramiding problem that arises when the initial tax is absorbed.

• X = the gross bonus payment

• Y = the net payment desired

• W = the federal income tax withholding rate (assuming the bonus is paid separately from regular wages and taxed at the flat 25%)

• F = the FICA tax rate (the Social Security tax rate of 6.2% + the Medicare tax rate of 1.45%-note the 2009 taxable wage base of $106,800, up from $102,000 in 2008) for Social Security purposes

Using the formula and substituting known amounts, you would calculate the gross bonus payment as follows:

X = Y + WX + FXX = $100 + .25X +. 0765XX = $100 + .3265X.6735X = $100X = $148.48

Therefore, you must pay an employee $148.08 for the employee to receive a tax-free $100 bonus.

Remember, any time you pay an employee's tax liability, the amount you pay is considered wages to the employee and is subject to Social Security, Medicare, and federal income tax withholding. In addition, any federal income tax you absorb for an employee is subject to the employer portion of Social Security and Medicare taxes.

Social Security and Medicare formula. The IRS has also released guidance for when you only want to pay the employee Social Security and Medicare tax from a particular payment.

To figure the employee's increased wages in this situation, divide the stated pay (the amount you pay without taking into account your payments of the employee's taxes) by the applicable factor for the year. The factor is determined by subtracting from 1 the combined Social Security and Medicare rate for the year the wages are paid. For 2009, the factor is .9235 (1 minus .0765). This formula will work when stated pay is $106,800 or less. When stated pay is more than $106,800 several other calculations are required because the Social Security wage base does not apply to Medicare.