Every month, billions of dollars are paid out in U.S. unemployment compensation to claimants, even as the unemployment rate has been at historical lows. The federal government estimates that $30.5 billion in unemployment benefits were paid in 2023.
The unemployment insurance system is often confusing, though, for both unemployed workers and employers. Here are answers to some of the most common questions about the system.
What is unemployment insurance?
Whether known as unemployment compensation or unemployment insurance, it’s essentially a temporary wage replacement program for eligible former employees going through involuntary unemployment. Eligible claimants receive payments that represent a percentage of their former wages.
The U.S. system is a federal-state program jointly run by the federal government and state unemployment agencies. The program is funded by federal unemployment taxes (known as FUTA taxes, for the Federal Unemployment Tax Act) and state unemployment taxes (SUTA taxes). FUTA tax funds are deposited into the Federal Unemployment Trust Fund, which is run by the U.S. Department of Labor (DOL).
Who receives unemployment benefits?
Eligible claimants generally are former employees who are currently unemployed for reasons beyond their control, such as layoffs, furloughs, and the end of seasonal work. In some cases, unemployment benefits may be available if the employee quit for good cause or was fired for something other than misconduct. Independent contractors generally aren’t eligible.
Each state sets its own eligibility rules for unemployment benefits. When evaluating a former employee’s eligibility, many states require that a claimant:
- Has earned at least a certain amount of wages within the previous 12-24 months,
- Has worked consistently for the previous 12-24 months, and
- Is actively looking for a new job.
Claimants usually must provide evidence of their job search on an ongoing basis to continue receiving unemployment benefits.
How long can a claimant receive unemployment benefits?
Unemployment compensation payments are made for a certain period of time or until a claimant finds a job, whichever comes first. In most states, claimants can receive up to 26 weeks of benefits.
The basic Extended Benefits program provides claimants with up to 13 additional weeks of benefits when a state is experiencing high unemployment rates. Some states have also established a voluntary program that pays up to seven additional weeks (for a maximum of 20 weeks) of extended benefits during periods of extremely high unemployment.
Who pays unemployment taxes?
Under the IRS’s general test for determining which employers must pay FUTA tax, you’re liable if you:
- Paid wages of $1,500 or more to employees in any calendar quarter during the current or previous tax year, or
- Had one or more employees for at least some part of a day in any 20 or more different weeks in the previous year or 20 or more different weeks in the current tax year, counting all full-time, part-time, and temporary employees.
The IRS has separate tests for household employers and agricultural employers.
In addition, three states require employees to contribute to their state unemployment compensation funds—Alaska, New Jersey, and Pennsylvania. Employers in those states must withhold the appropriate amounts from their paychecks and remit the funds to the state.
In Alaska, the employee contribution rate is equal to 27% of the average benefit-cost rate but not less than 0.5% or more than 1.0%. In New Jersey, the employee contribution rate is 0.425%. Depending on the adequacy of the fund balance in a given year, Pennsylvania employees pay contributions ranging from 0.0% to 0.08% of total gross covered wages earned in employment.
What is the FUTA tax rate?
The FUTA tax due is 6% of the first $7,000 of an employee’s wages during the year (known as the wage base). But employers may qualify for a credit of up to 5.4%, which would reduce the FUTA tax rate to 0.6%, or $42 per employee each year.
You can receive the credit if you pay your SUTA tax in full by the due date of your IRS Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return” (generally, Jan. 31 of the following year) and on all of the same wages that are subject to the FUTA tax.
The credit, however, isn’t available to employers in so-called “credit reduction states.”
What is a credit reduction state?
A credit reduction state is one that has borrowed money from the Federal Unemployment Trust Fund to pay unemployment benefits and hasn’t repaid it. If a state has outstanding loan balances with the trust on Jan. 1 for two consecutive years and doesn’t repay the full amount due by Nov. 10 of the second year, the FUTA tax credit rate for employers in the state will be reduced until the amount is repaid.
The reduction amount is 0.3% for the first year. It goes up another 0.3% for the second year and an additional 0.3% for each year after that. Further reductions may kick in after the third and fifth taxable years if the loan balance remains unpaid.
How does credit reduction affect employers’ FUTA tax liability?
If you’re in a credit reduction state, your FUTA tax liability will be higher than it would be otherwise. For example, in the first year of credit reduction, your FUTA tax credit would be only 5.1% (5.4% less 0.3%), with an effective FUTA tax rate of 0.9% (assuming you’re otherwise eligible for the reduction).
Are any employers exempt from FUTA tax?
The IRS exempts 501(c)(3) nonprofits from FUTA.
What are employers’ reporting and deposit obligations for FUTA tax?
If you’re liable for FUTA tax during a tax year, you must file IRS Form 940, “Employer’s Annual Federal Unemployment Tax Return,” by Jan. 31 of the following year. But, if you deposited all of your FUTA tax when it was due, you have until Feb. 10 to file. If the due date is on a weekend or legal holiday, the form is due the next business day
Deposits for the FUTA tax are required for the quarter within which your FUTA tax due exceeds $500. That means you may need to deposit FUTA taxes before you file Form 940. Deposits must be made by the end of the month following the end of the quarter.
If your FUTA tax liability is $500 or less in a quarter, carry it forward to the next quarter until your cumulative FUTA liability is more than $500. You must then deposit your FUTA tax for the quarter by the last day of the month at the end of the quarter.
If your FUTA tax liability for the fourth quarter (including any undeposited amount from prior quarters) is $500 or less, you can either deposit the amount or pay the tax with your Form 940 by Jan. 31. The fourth quarter payment should also include any liabilities owed for credit reduction. Deposits must be made through the Electronic Federal Tax Payment System.
What is the SUTA tax rate?
There’s no universal SUTA tax rate—it varies by state. Each state usually has a range of SUTA tax rates, with different rates for construction employers and non-construction employers, as well as new employers and those with an “experience rating” based on several years of unemployment claims paid to former employees.
Experience rating is the system used by state unemployment agencies to assign tax rates based on objective factors directly related to unemployment risk. It reflects the idea that employers with the lowest risk of unemployment should pay the least amount of state unemployment taxes and those with higher risk should have higher tax rates. The type of experience rating systems and the factors used to measure unemployment risk vary from state to state.
Other factors that may affect the state unemployment tax rate include:
- The employer’s industry,
- The size of the employer’s payroll,
- The number of employees,
- The amount in the state trust fund, and
- The amount of contributions paid into the fund less benefit payments paid out of the employer’s account.
Because of the many variables in states’ taxable wage bases and rates, benefit formulas, and economic conditions, actual tax rates vary greatly among the states and among individual employers within a state. For example, the rate for new employers in 2024 range from as low as 0.45% in South Carolina to as high as 3.95% in Illinois.
What is the SUTA tax wage base?
The wage base differs by state, too, and is usually higher than the FUTA tax wage base —only Arkansas, California, and Florida use a $7,000 wage base. For example, the wage bases in New York and Pennsylvania for 2024 are $12,300 and $10,000 respectively. At the other end of the spectrum, Alaska uses a wage base of $49,700. The highest wage base is in Washington state, ringing in at $68,500.
Are any employers exempt from SUTA tax?
Different states offer different exemptions. California, for example, has a lengthy list of services that are exempt from unemployment insurance taxes, including services provided by:
- Children under the age of 18 employed by a parent or partnership of parents only,
- A spouse employed by spouse,
- A registered domestic partner employed by registered domestic partner, and
- A parent employed by a son or daughter.
What are employers’ reporting and deposit obligations for SUTA tax?
The requirements are state-specific, so you should check with your state unemployment tax agency.
How can I reduce my unemployment tax liability?
The good news is that your unemployment insurance tax liability amount isn’t totally out of your control. You can take some steps to cut it, including:
- Verifying the benefits charges against your account for payments to former employees by the state unemployment tax agency (most states have improper payment rates of 10% or more),
- Avoiding layoffs,
- Contesting illegitimate unemployment claims,
- Keeping thorough records of involuntary terminations, including documentation of any misconduct, regular performance reviews, and other performance metrics.
- Making your unemployment insurance tax deposits on a timely basis to avoid penalties.
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