How Unemployment Insurance Taxes Could Impact Your Business
Unemployment Insurance Taxes and Your Business
Understanding the complex process of unemployment insurance taxes can be difficult, but you should know how UI taxes are calculated and how it may impact your business.
The UI system is funded by state and federal taxes (see our blog on federal unemployment tax)– which employers must pay. In order to determine how much an employer must pay towards unemployment insurance taxes, an “experience rating” is applied to the process.
This experience rating is usually based on the employer’s size, the amount the employer has paid into the system and the how often UI benefits were collected by former employees.
Along with the experience rating, there may be other factors that can impact unemployment insurance taxes an employer pays:
- Size of Employer. A smaller employer will have lower overall wages so a single UI claim may have more of an impact on the company than on a larger employer.
- Type of Employer. Not all employers are subject to unemployment tax. For example, some charitable organizations are exempt from unemployment tax under §501(c)(3) of the Internal Revenue Code (although these employers are required to reimburse the state for all benefits paid to former employees).
- Type of Worker. Employers may not have to pay unemployment insurance taxes for certain workers who are not classified as employees. For instance, the IRS states that UI tax does not have to be paid on true independent contractors (remember that the state will determine whether a person is an independent contractor and not rely on the employer’s classification).
- Claim Filing Date. When the UI claim is filed, the filing date determines the base period (usually it’s the first four of the last five completed quarters worked). The wages that will be used to calculate UI benefits are taken from the base period and then the employer taxes are calculated.
- Employee’s Length of Time Worked. An employer may be unaffected (or in some states have greatly reduced liability) by a UI claim if no wages were earned by the employee from that employer in the base period. The longer an employee works for an employer the more likely that a later UI claim will include the employer in the base period.
- Amount of Wages Earned. The higher an employee’s wages were when employed, then the higher amount of UI benefits they may receive, which may increase employer taxes.
- Benefits paid to the employee. If a former employee receives less than the potential maximum benefit, the employing unit’s tax rate may be less. The amount of benefits paid are based upon the wages earned by the employee, so a higher paid employee will generally have a higher benefit rate.
- Nature of the separation. The UI office determines if the former employee meets eligibility criteria for UI benefits. If a former employee fails to meet eligibility, UI benefits are not paid and the employer’s tax rates are not affected.
A UI claim will happen at some point – when it does affect your business, it’s smart to consult with a third-party expert to ensure the process is without errors.