What is Unemployment Tax, and How Much are You Going to Pay?

Unemployment taxes can be challenging for new and small business owners to understand. Read this guide to navigate the terminology and potentially reduce your tax rate.

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When employees are out of work through no fault of their own, unemployment insurance provides monies to tide an individual over until they can find another position. We’re all familiar with unemployment compensation and how it helps workers bridge the gap between jobs.

From a business owner’s point of view there are some basics that apply to unemployment taxes that can help you understand the taxes and potentially reduce your rates. There are two main types of unemployment taxes — federal and state.

The Federal Unemployment Tax Act (FUTA) is administered by the Department of Labor. All businesses must pay FUTA taxes unless they are government or educational organizations or are exempt as a qualified 501(c)3 charitable or religious organization under IRS guidelines. FUTA taxes are paid to the federal government.

Each state has a State Unemployment Tax Act (SUTA). Organizations that are exempt under FUTA will also be exempt from SUTA taxes. Each state sets its own guidelines for unemployment taxes, which are paid directly to the state by the employer.

Who pays unemployment taxes?

Employers are fully responsible for unemployment taxes. Unlike other salary deductions, employees do not contribute to unemployment tax payments. Businesses make payments for FUTA through their federal payroll tax contributions. For SUTA, through state payroll tax contributions.

What are unemployment tax rates?

The current FUTA rate is 0.6% of the first $7,000 of wages: this $7,000 cap is called the taxable wage base. Any wages over $7,000.00 per year are not subject to federal unemployment tax.

Under SUTAs, tax rates in each state range from a low of 1% to 3.4%. The taxable wage base, or amount of wages that are taxable under state unemployment laws, also varies by state. Currently the lowest is at the $7,000 FUTA rate but the taxable wage base goes to a high of $47,300 in Washington State.

Employers must pay both federal and state unemployment taxes either quarterly or when they make their payroll contributions. Business should check with their local Department of Labor to determine when and where payments must be made.

How are unemployment tax rates determined?

A factor in the amount of state unemployment taxes due is the rate of unemployment. While FUTA tax rates are not variable: state unemployment tax rates are. Depending on the state, industry and employer experience the rate may be higher or lower. In some industries, like retail and fast food, the rate of unemployment is high: so many states assign a higher unemployment tax rate to businesses with those types of staffers. Other industries may have a lower rate of overall unemployment, so for these companies, even in the same state, the rate can be different.

For new businesses, states will assign a starting tax rate, sometimes based on the industry. But rates can change over the lifetime of the business. An organization with a higher amount of unemployment claims over time will typically see their unemployment tax rate increase. Those with fewer claims often enjoy a rate reduction.  These are called ‘experience ratings’ since as a company experiences claims, the state is better able to assess their risk and set a payment rate that’s appropriate. How and how often experience ratings are determined and reevaluated varies by state.

Can I lower my company’s unemployment tax rates?

There are several ways to reduce the amount of federal and state unemployment taxes a business is required to pay. At the federal level, discounts are provided to employers who are conscientious about paying their taxes. Under federal guidelines, employers that make their state SUTA contributions on time can reduce the amount of FUTA taxes due. If your company verifiably makes its state unemployment contributions regularly and without any late payments, the federal government grants a 5.4% credit against any necessary FUTA payments. This can reduce a business’ FUTA costs by 90%, bringing the FUTA tax rate down to 0.6%.

When an employee is eligible to collect benefits varies by state. Typically employees have had to be on the job (and their employer paying into the system) for a specific amount of time before they can collect unemployment compensation. This is called the “base period.” In most states, the base period is one year, but it can vary. When you hire a new employee, it may be advantageous to make sure your new hire probationary period is well within the base period. If your probationary period is 6 months, for example, but the base period to be eligible for unemployment compensation is 3 months in your state, you’ll be responsible for that person’s claim. Make sure to fairly evaluate new hires during probationary periods: it can help reduce your overall claims experience.

A final way to reduce costs for state unemployment insurance is by keeping your experience levels down. Employees are eligible for benefits if job loss was outside their control. Laid off, downsized or eliminated staffers qualify but those who resign and employees who were fired for policy or rule violations are not. If an employee quits, ask for their resignation in writing, so you have a copy should they file for unemployment compensation. If the employee was fired for cause, make sure you have ample evidence of the rule violation that led to their dismissal. You’ll want to have documentation of oral and written warnings, disciplinary actions taken and any other evidence that the employee had the ability to maintain their position, had they followed the rules and guidelines. This evidence, presented in the event of a claim, could invalidate their ability to collect.

Unemployment taxes can be challenging for new and small business owners to understand. Following the basics: making payments on time, keeping experience down and maintaining the proper documents can help make it easier, and possibly less costly.

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