What is unemployment insurance and how does it work?

Unemployment insurance is a government program that provides financial support to eligible employees after they’ve been terminated through no fault of their own. Eligible workers typically receive a check each week until they are once again employed or they exhaust the covered time period.

Which employees are eligible for unemployment insurance after they’re terminated?

The employees who are eligible for unemployment insurance after they’re terminated are specified in both federal and state law. In general, employees are not eligible for unemployment insurance if they:

  • Are terminated for cause; or
  • Quit their job.

To learn more about which employees are eligible for unemployment insurance, click here.

Who pays for unemployment insurance?

Employers pay for unemployment insurance through both federal and state payroll taxes. The federal tax is called FUTA (Federal Unemployment Tax Act) and the state tax is called SUTA (State Unemployment Tax Act). These taxes are:

  • Collected while a worker is employed and end when the employee is terminated; and
  • Shown on your employees’ pay stubs each payday.

Does my business need to pay unemployment insurance taxes?

Generally, your business needs to pay both federal and state unemployment insurance taxes if you:

  1. Paid $1,500 or more in wages to employees during in any quarter of one calendar year; or
  2. Had at least one employee any day of a week for 20 or more weeks in a calendar year. These weeks do not have to be consecutive.

Be careful however, as many states have their own twist on the books about which employers needs to pay unemployment insurance taxes. Before doing so check your state’s Department of Labor website to discover the exact rules that affect your situation.

What are my unemployment insurance tax rates?

Your unemployment insurance tax rates are set at both the federal and state levels.

Federal taxes: The current federal unemployment insurance tax  rate is 6% and applies to the first $7,000 paid to each employee (called the “wage base”) during the year. This means that the maximum FUTA that you can owe during the year is .06 x $7,000 or $420 per employee.

However, if you pay your state unemployment taxes on time, you’ll likely earn a 5.4% federal tax credit, making the effective FUTA rate .6% and bringing your maximum payment per employee down to .006 x $7,000 or $42.

State taxes: Each state uses a different tax rate and wage base for their unemployment tax. To find out the details for your state, click here or visit your state’s Department of Labor website.

What happens when an employee claims unemployment insurance?

When an employee claims unemployment insurance, you’ll receive a “Notice of Unemployment Insurance Claim Filed” from your state’s unemployment office (here’s one example from California).

This form is your state’s attempt to:

  • Establish your ex-employee’s eligibility for unemployment insurance; and
  • Discover how much the ex-employee has and will be paid in order to determine the amount of money to payout each week.

If everything is in order, complete the form so the state can begin sending checks to your ex-employee.

In some cases however, you might want to contest an unemployment insurance claim.

Why would I contest an unemployment insurance claim?

The primary reason to contest an unemployment insurance claim is because you believe the former employee who filed the claim is not eligible for it. If you want to protest the claim, it’s best to have documentation that backs up your reasons for terminating that employee and why that employee is not eligible.

Can my unemployment insurance change?

Yes, your unemployment insurance tax rates can change, and can go up if more former employees successfully claim it. States have both a minimum and maximum unemployment insurance tax rate. If you want to stay on the lower end, you’ll want as few former employees participating in the program as possible.

This article provides general information and shouldn’t be construed as legal or HR advice. Since employment laws may change over time and can vary by location and industry, please consult a lawyer or HR expert for advice specific to your business.