In the heat of a mergers and acquisitions (M&A) negotiation, companies often reach for any tool that promises to keep key talent on board and focused. One of those tools is the tax “gross-up”—an extra payment designed to cover an executive’s personal tax bill so the executive ends up “whole” after receiving a bonus, severance check, or change-in-control payment.

At first glance, a gross-up looks like a tidy solution: the executive receives the intended amount without being penalized by taxes, and the buyer or seller preserves continuity in a fragile time. Yet, as practitioners have discovered, gross-ups tend to solve one problem while quietly spawning two more. Below is a closer look at how the mechanism works, why it became popular, and the new headaches it often introduces.

What Exactly Is a Tax Gross-Up?

A tax gross-up is an additional cash payment made by a company to cover the taxes its employee—or former employee—owes on a particular compensation event. The business effectively “brings home” the employee’s after-tax amount by paying enough extra to cover federal, state, and sometimes even local taxes (and the taxes on the gross-up itself).

How Gross-Ups Work in a Deal Context

• An executive becomes entitled to a special bonus, retention award, or severance payout triggered by an acquisition or merger.
  
• The company calculates the tax due on that payment, then adds a supplemental amount so the executive’s net take-home equals the intended figure.
  
• Because the gross-up is itself income, the company often has to “gross-up the gross-up,” creating a cascading effect and inflating the overall cost.
  

The practice first became fashionable in the late 1980s as a reaction to §280G of the Internal Revenue Code, which imposes a 20 percent excise tax on “excess parachute payments” made when a change in control occurs. Rather than see valued leaders lose a fifth of their reward, boards simply agreed to pick up the tab.

Why Companies Offer Gross-Ups: Good Intentions, Real Benefits

Companies do not set out to waste cash. They adopt gross-ups for practical, sometimes urgent, reasons:

Compensation Certainty for Key Executives

Change-in-control events are stressful. Knowing their after-tax payout in advance allows executives to focus on negotiating, integrating, or even just staying in their seats rather than polishing résumés.

Talent Retention During an M&A Process

Buyers dislike uncertainty. A gross-up can keep mission-critical leaders from exiting mid-deal. In heated auctions, sellers sometimes promise gross-ups to make their team “stickier” and thereby lift valuation.

Competitive Benchmarking and Peer Pressure

If peer companies routinely offer gross-ups, directors may feel they have no choice. No board wants to be singled out for treating its CEO less favorably than the CEO down the street.

The Unintended Consequences: Two New Headaches

Unfortunately, the same mechanism that calms nerves on Day One can ignite controversy and cost overruns on Day Two. Two issues recur so often that many boards now view gross-ups as a last-ditch tool rather than a default setting.

Cost Can Spiral Beyond Projections

A gross-up is not a straightforward 20 percent surcharge. Because the tax itself is income, each layer of calculation demands another payment—an effect sometimes called “the infinite regress of gross-ups.” Add in state and local taxes plus Medicare surcharges, and a $3 million parachute payment can quickly edge toward $5 million. In a competitive M&A bid, that unexpected delta can tip the economics of a deal.

Optics, Governance Risk, and Shareholder Backlash

In today’s environment of heightened scrutiny, Institutional Shareholder Services (ISS), Glass Lewis, and activist funds routinely flag gross-ups as poor pay practice. Headlines about “executives paid to avoid taxes” resonate poorly with employees whose own deductions are not reimbursed. Negative attention can darken the glow of an otherwise successful transaction and erode goodwill the instant the ink dries.

A secondary governance wrinkle emerges if the employment contract extends beyond the deal. The acquiring company must live with—and disclose—the gross-up policy after closing, potentially complicating its own compensation philosophy.

Navigating Gross-Ups the Smart Way

Boards are not powerless. Several practical steps can blunt the downsides while preserving the upside of tax protection.

Design Alternatives to Blanket Gross-Ups

• Cap the Benefit: Instead of covering the full tax, offer a fixed-dollar supplement that reduces but does not eliminate the executive’s burden.
  
• Sunset Clauses: Make the gross-up available only for transactions signed within a specified window (e.g., 18 months), preventing indefinite exposure.
  
• Modified Cutback: Provide the smaller of (a) a gross-up or (b) a reduction in the change-in-control payment to avoid the excise tax threshold. Many executives prefer certainty even if it means a slightly smaller check.Stress-Test the Math Early

Finance teams should model multiple scenarios—different deal values, varying equity prices, and alternative state tax outcomes—before the board approves any gross-up. Sensitivity analysis highlights worst-case costs and informs negotiations with potential buyers who might have to assume the liability.

Mind the Disclosure Language

Public companies must reveal gross-up commitments in proxy statements, and private sellers often disclose them in data rooms. Clear, concise explanations pre-empt confusion and reduce the odds of last-minute renegotiations when a buyer’s counsel discovers an open-ended obligation.

Engage Shareholders and Proxy Advisers Proactively

If a gross-up is truly necessary—perhaps to complete a transformative sale—explain why. Investors are more forgiving when they understand the strategic context. Offer a timeline for phasing out the practice post-deal and tie any future tax protection to rigorous performance conditions.

Best-Practice Checklist for Today’s Boards

• Exhausted alternatives such as retention bonuses, equity acceleration, or enhanced severance without tax reimbursement
• Modeled total cash outlay under optimistic, base-case, and pessimistic tax scenarios
  
• Reviewed peer data for both prevalence and investor reception
  
• Drafted disclosure language that balances transparency with strategic confidentiality
  
• Established a sunset or cap to limit exposure
  

The Regulatory Landscape Is Still Shifting

Tax rules seldom stand still. Over the past decade, a steady drumbeat of shareholder proposals, “say-on-pay” votes, and SEC disclosure requirements has nudged companies away from open-ended gross-ups. Meanwhile, Congress periodically flirts with tightening §280G or expanding excise taxes to additional compensation categories.

Any board relying on a gross-up today should prepare for a world in which the practice becomes increasingly rare—and increasingly controversial.

In the heat of a mergers and acquisitions (M&A) negotiation, companies often reach for any tool that promises to keep key talent on board and focused. One of those tools is the tax “gross-up”—an extra payment designed to cover an executive’s personal tax bill so the executive ends up “whole” after receiving a bonus, severance check, or change-in-control payment.

At first glance, a gross-up looks like a tidy solution: the executive receives the intended amount without being penalized by taxes, and the buyer or seller preserves continuity in a fragile time. Yet, as practitioners have discovered, gross-ups tend to solve one problem while quietly spawning two more. Below is a closer look at how the mechanism works, why it became popular, and the new headaches it often introduces.

What Exactly Is a Tax Gross-Up?

A tax gross-up is an additional cash payment made by a company to cover the taxes its employee—or former employee—owes on a particular compensation event. The business effectively “brings home” the employee’s after-tax amount by paying enough extra to cover federal, state, and sometimes even local taxes (and the taxes on the gross-up itself).

How Gross-Ups Work in a Deal Context

• An executive becomes entitled to a special bonus, retention award, or severance payout triggered by an acquisition or merger.
  
• The company calculates the tax due on that payment, then adds a supplemental amount so the executive’s net take-home equals the intended figure.
  
• Because the gross-up is itself income, the company often has to “gross-up the gross-up,” creating a cascading effect and inflating the overall cost.
  

The practice first became fashionable in the late 1980s as a reaction to §280G of the Internal Revenue Code, which imposes a 20 percent excise tax on “excess parachute payments” made when a change in control occurs. Rather than see valued leaders lose a fifth of their reward, boards simply agreed to pick up the tab.

Why Companies Offer Gross-Ups: Good Intentions, Real Benefits

Companies do not set out to waste cash. They adopt gross-ups for practical, sometimes urgent, reasons:

Compensation Certainty for Key Executives

Change-in-control events are stressful. Knowing their after-tax payout in advance allows executives to focus on negotiating, integrating, or even just staying in their seats rather than polishing résumés.

Talent Retention During an M&A Process

Buyers dislike uncertainty. A gross-up can keep mission-critical leaders from exiting mid-deal. In heated auctions, sellers sometimes promise gross-ups to make their team “stickier” and thereby lift valuation.

Competitive Benchmarking and Peer Pressure

If peer companies routinely offer gross-ups, directors may feel they have no choice. No board wants to be singled out for treating its CEO less favorably than the CEO down the street.

The Unintended Consequences: Two New Headaches

Unfortunately, the same mechanism that calms nerves on Day One can ignite controversy and cost overruns on Day Two. Two issues recur so often that many boards now view gross-ups as a last-ditch tool rather than a default setting.

Cost Can Spiral Beyond Projections

A gross-up is not a straightforward 20 percent surcharge. Because the tax itself is income, each layer of calculation demands another payment—an effect sometimes called “the infinite regress of gross-ups.” Add in state and local taxes plus Medicare surcharges, and a $3 million parachute payment can quickly edge toward $5 million. In a competitive M&A bid, that unexpected delta can tip the economics of a deal.

Optics, Governance Risk, and Shareholder Backlash

In today’s environment of heightened scrutiny, Institutional Shareholder Services (ISS), Glass Lewis, and activist funds routinely flag gross-ups as poor pay practice. Headlines about “executives paid to avoid taxes” resonate poorly with employees whose own deductions are not reimbursed. Negative attention can darken the glow of an otherwise successful transaction and erode goodwill the instant the ink dries.

A secondary governance wrinkle emerges if the employment contract extends beyond the deal. The acquiring company must live with—and disclose—the gross-up policy after closing, potentially complicating its own compensation philosophy.

Navigating Gross-Ups the Smart Way

Boards are not powerless. Several practical steps can blunt the downsides while preserving the upside of tax protection.

Design Alternatives to Blanket Gross-Ups

• Cap the Benefit: Instead of covering the full tax, offer a fixed-dollar supplement that reduces but does not eliminate the executive’s burden.
  
• Sunset Clauses: Make the gross-up available only for transactions signed within a specified window (e.g., 18 months), preventing indefinite exposure.
  
• Modified Cutback: Provide the smaller of (a) a gross-up or (b) a reduction in the change-in-control payment to avoid the excise tax threshold. Many executives prefer certainty even if it means a slightly smaller check.
  

Stress-Test the Math Early

Finance teams should model multiple scenarios—different deal values, varying equity prices, and alternative state tax outcomes—before the board approves any gross-up. Sensitivity analysis highlights worst-case costs and informs negotiations with potential buyers who might have to assume the liability.

Mind the Disclosure Language

Public companies must reveal gross-up commitments in proxy statements, and private sellers often disclose them in data rooms. Clear, concise explanations pre-empt confusion and reduce the odds of last-minute renegotiations when a buyer’s counsel discovers an open-ended obligation.

Engage Shareholders and Proxy Advisers Proactively

If a gross-up is truly necessary—perhaps to complete a transformative sale—explain why. Investors are more forgiving when they understand the strategic context. Offer a timeline for phasing out the practice post-deal and tie any future tax protection to rigorous performance conditions.

Best-Practice Checklist for Today’s Boards

• Exhausted alternatives such as retention bonuses, equity acceleration, or enhanced severance without tax reimbursement
  
• Modeled total cash outlay under optimistic, base-case, and pessimistic tax scenarios
  
• Reviewed peer data for both prevalence and investor reception
  
• Drafted disclosure language that balances transparency with strategic confidentiality
  
• Established a sunset or cap to limit exposure
  

The Regulatory Landscape Is Still Shifting

Tax rules seldom stand still. Over the past decade, a steady drumbeat of shareholder proposals, “say-on-pay” votes, and SEC disclosure requirements has nudged companies away from open-ended gross-ups. Meanwhile, Congress periodically flirts with tightening §280G or expanding excise taxes to additional compensation categories.

Any board relying on a gross-up today should prepare for a world in which the practice becomes increasingly rare—and increasingly controversial.

‍