A gross up clause is used to make sure that employers will compensate their company's executives when they are taxed for a Golden Parachute Payment.

What are Gross Up Clauses?

Under Code Sections 4999 and 280G, Golden Parachute Payments are subject to a 20 percent excise tax. When this tax is imposed on a company's executive, a gross up clause mandates that the employer will cover this tax. It's common for Executive Employment Agreements to include a gross up clause.

The practice of covering the Golden Parachute excise tax is called grossing up. When this cause is activated, an additional amount of money must be provided to the payee to make sure that they would receive the same amount of money that they would if the tax had not been levied.

While gross up clauses are most typically found in Executive Employment agreements, they can also be used in other types of contracts:

Leasing and Gross Up Clauses

When the term gross up is used, it is usually referring to fully serviced leases. In these leases, a tenant pays a base amount for their rent and then pays additional fixed amounts for other services provided by their landlord. Gross up clauses in leases allow for tenants to be charged a prorated expense share as if the building were occupied between 90 to 100 percent, even if this isn't the case.

Gross up charges are almost always paid for expenses that can vary, meaning they change depending on several factors, including how many occupants currently reside in the building.

How Do Landlords Benefit from Gross Up Clauses?

Gross up clauses can be beneficial for landlords and just as disadvantageous for tenants. For example, let's assume that you are the first tenant in a commercial building and you decide to rent 10,000 feet of space, which is ten percent of the available space in the building. In typical scenarios, you would need to cover ten percent of the buildings variable costs because this is the amount of available building space that you are occupying.

However, let's assume that your landlord is having trouble renting out the other 90 percent of the building and that this difficult extends for several months. If the tenant agreement doesn't have a gross up clause, your landlord would have to cover the remaining 90 percent of variable costs out of their own pocket. However, if the tenant agreement does contain a gross up clause, your landlord can increase the amount of variable costs that you need to cover, possibly as high as 100 percent.

Typical Gross Up Clauses

When investing in real estate, both lenders and owners try to limit their financial liability in whatever way they can, mostly because rates of vacancy can be extremely unstable. If no measures are taken, a landlord will likely be unable to pass the expenses of operating their building to their tenants.

Preventing these circumstances is usually a matter of including a gross up clause in a commercial agreement. These clauses make it easier for a landlord to calculate operating costs for a mostly vacant building the same way they would if the building were almost entirely occupied.

As you might imagine, these clauses work in the interests of the landlord and can seem unfair to tenants that are required to cover expensive operating costs. Despite this appearance, both tenants and landlords should request that their commercial lease include this clause, as it can help control costs.

Cost Certainty

Gross up clauses are related to operating costs and how they can be passed through to tenants. Property owners use these clauses to optimize their income, as tenants will be required to cover costs such as:

  • Building insurance and real estate taxes
  • Janitorial services
  • Utilities

Without this clause in place, landlords will need to cover all costs by themselves, making it difficult for them to know how much they will need to pay on a year to year basis. Depending on the variable costs, the lack of gross up divisions can also reduce income to a large degree.

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