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Understanding Income Tax Gross-Ups

January 10, 2023


Understanding Income Tax Gross-Ups

In this blog we discuss personal expenses, the income tax gross-up associated with them, and their impact on the calculation of a person’s income available for support.

In our previous blog, The Basics of Child and Spousal Support – Income for Support Reports, we discussed several adjustments that are made when calculating an individual’s income for support. In this blog, we delve deeper into one of those adjustments and how it impacts an individual’s income for support: personal expenses and the corresponding income tax gross-up.

Taxable Benefit from Personal Expenses

When personal expenses are written off through a corporation, the business owner is not only receiving the benefit of having their own expenses paid for, but they are also taking advantage of tax savings as the expenses are paid with “pre-tax” corporate dollars. To account for this tax advantage, when calculating income for support, we apply a tax gross-up to personal expenses. To demonstrate this, we use the following example:

Under Scenario A, Dan owns a business and does not pay himself a salary. All of Dan’s personal expenses are included within the expenses of the company and accumulate to $100,000.

Under Scenario B, Jane owns a business and pays herself a salary of $141,500 and does not include any of her personal expenses within the expenses of her company. Jane, however, must pay income taxes of approximately $41,500 on the salary she earns, with her net income after tax equaling $100,000.

In the above scenarios, you can see that Dan is receiving a $41,500 taxable benefit by including his personal expenses within the expenses of the company. Had he paid for the expenses out of his own pocket, he would’ve had to earn a salary equivalent to that of Jane, to have a net income after tax equalling $100,000. This $41,500 is the income tax gross-up on the personal expenses we calculate and include within the calculation of income for support.

How is an income tax gross-up calculated?

As noted above, the income tax gross-up takes into account the benefit a business owner may receive when expensing their personal expenses through their company.

For example, let’s say Elle is the sole shareholder of a company, and within the expenses of the company there are personal expenses paid on behalf of Elle that amount to $10,000. For this example, we will assume Elle’s marginal tax rate is 53.53%.

Personal expenses A $10,000
Elle’s marginal tax rate B 53.53%
Gross-up on personal expenses C = A / (1-B)-A* $11,519

*11,519 = 10,000 / (1 – 0.5353) -10,000

As a result, Elle’s income for support calculation consists of $10,000 in personal expenses and the gross up of $11,519, totaling $21,519. This shows that Elle would have to make $21,519 to pay for $10,000 of her own personal expenses, with $11,519 going to income taxes.

Whether your income is simple, complex, or anywhere in between the experts at Davis Martindale can help determine an appropriate income to calculate support. Call us today for a personalized discussion.