Gross-up
Gross-up is a tax concept relevant to M&A transaction structuring — how it applies affects a seller's after-tax proceeds and a buyer's cost basis.
Full Definition
A gross-up is an additional payment made to compensate a recipient for the income tax they will owe on a payment — making them whole on an after-tax basis. Rather than the recipient netting less than expected due to taxes on the payment itself, the payor increases (grosses up) the payment so that the recipient ends up with the intended after-tax amount. Gross-ups appear in several distinct M&A contexts.
338(h)(10) election gross-up: The most common M&A gross-up is the payment a buyer makes to compensate a seller for the additional taxes incurred by agreeing to a 338(h)(10) election. Without the election, a stock sale would generate capital gains; with the election, a portion of the gain is recharacterized as ordinary income or depreciation recapture — costing the seller more in taxes. The gross-up compensates the seller for this incremental tax burden, making them indifferent between the election and no election on an after-tax basis.
Executive compensation gross-up: In employment and golden parachute agreements, a gross-up provision commits the company to pay the executive additional amounts to cover the 20% excise tax imposed on excess parachute payments under IRC §280G. If an executive receives $2M in golden parachute payments and owes $400K in excise taxes, a gross-up covers not only the $400K excise tax but also the income taxes on the gross-up payment itself — creating a cascading calculation that can significantly increase the total payout.
Calculating a gross-up: The gross-up calculation works in reverse from the desired after-tax result. If the recipient needs to net $1M after-tax and their marginal tax rate is 40%, the gross payment must be $1M / (1 − 0.40) = $1.667M. The $667K additional payment exactly covers the $667K × 40% = $267K in taxes on the gross-up itself, plus the $400K in taxes on the original $1M — resulting in a $1M net.
Negotiating gross-ups: Both sides negotiate gross-up provisions. Sellers want gross-ups that cover all incremental taxes, including state taxes and any net investment income tax. Buyers want to cap gross-ups at specific amounts or specific tax rates. The calculation methodology — including which taxes are covered and what rate applies — must be precisely defined in the purchase agreement to prevent post-close disputes.
Seller vs. Buyer Perspective
Never agree to a 338(h)(10) election without a properly calculated gross-up. The gross-up must be based on your actual, all-in tax rate — not a simplified federal-only calculation. State taxes vary dramatically (from 0% in Texas to 13.3% in California), and the gross-up calculation changes meaningfully by state. Have your tax advisor run the exact gross-up calculation for your specific situation and jurisdiction before agreeing to the election.
Model the full gross-up cost before you propose a 338(h)(10) election. The election gives you basis step-up value (tax shield from amortizing the purchase price over 15 years); the gross-up is its cost. Calculate the NPV of the step-up benefit versus the gross-up payment in your specific situation — the election only makes economic sense when the step-up NPV exceeds the gross-up cost, which isn't always the case. For executive compensation gross-ups, consider whether eliminating 280G exposure entirely (through deal restructuring or shareholder vote) is cheaper than agreeing to a gross-up.
Real-World Example
A seller agrees to a 338(h)(10) election that increases their tax liability by $480K compared to a stock sale — $380K federal (ordinary income at 37% vs. capital gains at 20% on depreciation recapture) plus $100K state. The buyer agrees to a gross-up covering the incremental $480K. But the gross-up payment is itself taxable income. The seller's combined federal and state marginal rate on the gross-up is 45%. The true gross-up needed: $480K / (1 − 0.45) = $872K. The buyer pays $872K more in purchase price; the seller nets exactly the same after-tax amount as if no election had been made.
Why It Matters & Common Pitfalls
- !Simplified gross-up calculations understate the payment. A buyer who calculates the gross-up based only on federal income tax and ignores state tax, net investment income tax, and the taxes on the gross-up payment itself will significantly underestimate the payment owed. The seller's tax advisor should produce the definitive calculation.
- !Gross-up disputes are common and expensive. Vague gross-up provisions ('the buyer will compensate seller for incremental taxes') without a specific calculation methodology generate post-close disputes. The purchase agreement should include the specific calculation formula, the tax rates to be applied, and who bears the risk of an IRS audit that changes the tax outcomes.
- !Executive gross-ups for 280G are a vestige of a past era. Most new employment agreements have moved away from full 280G gross-ups in favor of 'best net' provisions (the executive takes whichever is better: the full parachute or the amount that doesn't trigger excise tax). Full gross-ups are increasingly rare in new agreements because the cost is prohibitive.
- !State tax rates in gross-up calculations are non-trivial. In high-tax states (California, New York, New Jersey), state income taxes on a gross-up payment can add 10–13 percentage points to the effective rate — dramatically increasing the gross-up amount required. Use state-specific tax calculations, not national averages.
Frequently Asked Questions
What is Gross-up in M&A?↓
When does Gross-up come up in a business sale?↓
Related Terms
338(h)(10) Election
A joint tax election that lets a stock sale be treated as an asset sale for federal tax purposes, giving the buyer a stepped-up tax basis in the company's assets while the seller recognizes gain as if assets were sold.
Capital Gains (Short vs Long Term)
The tax treatment of gain from selling a capital asset (like a business). Long-term capital gains (asset held >1 year) are taxed at preferential federal rates (typically 20%); short-term gains and ordinary income can be taxed at up to 37%.
Purchase Price Allocation
The allocation of total purchase price across asset categories (inventory, equipment, real estate, goodwill, etc.) for tax purposes under IRC Section 1060 — affecting seller's tax treatment and buyer's future depreciation deductions.
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Disclaimer: The information provided on this page is for educational and informational purposes only. It should not be considered financial, legal, or investment advice. Business valuations depend on many factors specific to each situation. Always consult with qualified professionals — including business brokers, CPAs, and M&A attorneys — before making acquisition or sale decisions. LegacyVector is not a licensed broker, financial advisor, or attorney. Data shown may be based on limited samples and may not reflect current market conditions.
LegacyVector Research Team
Reviewed by M&A professionals · Updated April 2026