Is relocation reimbursement taxable? How to assess tax liability for employee relocation

There often comes a time when you need employees to move for your business. Perhaps you are opening a new location and want a few of your top team members to lead the charge. Or you may have the perfect promotional opportunity for an employee arise, but it’s at a different branch. When this happens, it’s common to offer relocation reimbursements.

Relocation reimbursements are a great way to incentivize and support employees in moving to a new work location based on changing business needs or promotional opportunities. Relocation benefits, including bonuses and relocation reimbursements, help make moving more appealing to employees. Often it’s still cheaper for the business than hiring and training someone new at the other worksite.

However, the laws regarding relocation expenses have changed in recent years, which can cause confusion for employers and employees. Expenses that could previously be deducted on an employee’s tax return may no longer qualify, and relocation benefits that previously could be paid out without counting towards a taxpayer’s income may now result in higher tax liabilities.

If you’re drafting up a relocation agreement for an employee or updating your relocation policy, it’s important to understand whether relocation reimbursements are taxable and how to navigate any tax considerations that come with the payments.

What is a relocation reimbursement?

Relocation reimbursement is funding provided to reimburse employees for moving expenses when they are required to relocate to a new area for work. While relocation reimbursement is sometimes offered at sign-on for a new job, it’s most commonly provided when employees transfer or accept a promotion at a new worksite. Employers pay the employee back for out-of-pocket relocation costs like packing and moving services, temporary housing, and travel expenses.

Relocation expenses typically reimbursed include:

• House-hunting trips. Employers will typically cover at least one trip to the new location for house-hunting and relocation planning.

• Travel expenses to the new location. Mileage reimbursement or airfare to move to the new location.

• Relocation of household goods. Packing and moving an employee’s personal belongings from their current residence to their new residence by a moving company.

• Interim housing. The cost of temporary housing arrangements such as short-term rentals or hotels. Employers typically cap the number of days that they will cover at around ten to fifteen days.

• Early lease termination costs. The cost to terminate a lease agreement early in order to move quickly.

Sometimes employers will offer a lump sum payment instead of reimbursing each individual moving cost or pay the vendor directly for moving services.

Is relocation reimbursement taxable for employees?

Yes, relocation reimbursements are considered a fringe benefit by the IRS and are subject to income taxes. Employers also need to pay standard payroll taxes on the additional income including federal, state, and FICA taxes (such as Medicare and Social Security).

The total amount paid or reimbursed will need to be added to the employee’s taxable income on their end-of-year tax forms. Be sure to track all reimbursements made and ensure that your business’ tax preparer and payroll department are handling these added payments properly when preparing annual form W-2 filings.

Can employees deduct their moving expenses?

Previously, individuals could deduct qualified moving expenses from their personal income taxes. However, the Tax Cuts and Jobs Act of 2017 changed that. The Act, which went into effect in 2018 and will remain until 2025, reimbursed moving expenses are taxable, and unreimbursed moving expenses are no longer deductible. Now only active duty service members may deduct moving costs.

Are moving expenses paid directly to vendors taxable?

Yes, paying vendors directly does not circumvent the tax obligation on relocation reimbursements. Employers will still need to report relocation assistance paid on behalf of an employee on the employee’s end-of-year tax forms, even if the payment was made to a vendor rather than to the employee.

Are relocation reimbursements tax deductible for employers?

Yes, while the Tax Cuts and Jobs Act changed the rules for moving expense deductions for employees, employers can still deduct the cost of reimbursement reimbursements paid out to employees. Employer-paid relocation expenses are typically considered business expenses that can be deducted. Check with your tax advisor to verify which expenses may be deducted.

How to help employees with relocation-related tax costs

The tax law changes that came with the Tax Cuts and Jobs Act can make relocation less appealing and more costly for employees. Here are a few ways to help minimize the impact of relocation tax costs.

Make employees aware of their tax obligations

While employers should not offer tax advice, they should make employees aware that relocation reimbursements or bonuses will be subject to income taxes. Since the changes are still relatively new, many employees may expect to not have to pay taxes on the reimbursement or plan to deduct expenses that are no longer eligible.

You don’t want your team members to get a huge surprise come tax season, so it’s helpful to lay out the potential tax liabilities in writing. It’s best to explicitly state in each employee relocation agreement that the staff member will be responsible for any applicable personal income taxes related to their relocation reimbursement. It’s also sometimes helpful to remind employees that they may adjust their tax withholdings.

Offering tax gross-ups for relocation bonuses

Some employers use something called a “tax gross-up” to offset the tax burden on their employees when offering a bonus or relocation payment. A tax gross-up is essentially an extra amount of money meant to cover the additional tax that will need to be paid on the relocation package.

The employer will typically calculate the employee’s expected tax liability on the employer-paid moving expense payments and add that to the employee’s moving expense reimbursement or relocation bonus. A flat calculation can be done based on the employee’s anticipated tax rate (you’ll need to verify the employee’s filing status and anticipated tax bracket to calculate the correct rate). For example, if an employee’s expected annual tax rate is 30% and you offer a relocation bonus for $10,000, the gross-up would be $3,000.

Some employers also attempt to include the tax implications of the gross-up in their calculations. With this calculation method, employers follow the formula:

Gross-up = [Desired Net Amount / (1 – Tax Rate)]

Employers add up all the different tax rates (federal income tax, state income tax, FICA taxes, etc.) to find the total tax rate to input into the formula. The net amount is the amount that you want the employee to end up with (typically the same number as the promised relocation bonus or reimbursement before the gross-up).

Employers are certainly not required to offer a tax gross-up, but it is a great way to make a relocation package more appealing to employees and help incentivize them to accept a transfer or reassignment. Plus if you are offering relocation reimbursement without a salary increase or added relocation bonus, it helps ensure that the employee isn’t actually losing money during a corporate relocation.