Many people mistakenly believe that Unemployment Insurance (UI) benefits come from a fund paid for by employees, such as Social Security or Medicare. however, it is employers who are financially responsible for unemployment benefits, and the costs are much higher than just the amount of a claim.
first, it helps to understand how unemployment insurance is financed.
Unemployment is financed almost entirely by employers. Only three states (Alaska, New Jersey, and Pennsylvania) impose unemployment taxes on employees, and it’s a small part of the total cost.
Unemployment is funded and taxed at both the federal and state levels:
- Federal unemployment tax (FUTA) is imposed at a flat rate on the first $7,000 paid to each employee. the current futa tax rate is 6%, but most states receive a 5.4% “credit” which brings it down to 0.6%. there is no action an employer can take to affect this rate. Some of this federal money is used for loans to states that don’t have enough in their UI trust funds to pay claims. if the loans are not repaid, the federal government raises that state’s employer tax rate.
- the state unemployment tax law (suta) tax is much more complex. Employers pay a certain tax rate (usually between 1% and 8%) on employees’ taxable earnings. in most states, that ranges from the first $10,000 to $15,000 an employee earns in a calendar year.
This is where it gets tricky. Each state has its own method of financing and its own calculation for determining the tax rate an employer pays. you can read about it here. For the purposes of this article, know that the tax is based on the employer’s taxable payroll, the amount the employer has paid into the unemployment system, and unemployment claims against the employer’s account (called “benefit charges” ).
This is called an experience rating and can go up or down over time based on employer payroll and unemployment claim history.
The Real Cost of Unemployment Claims: Rising Tax Rates.
The cost of an individual UI claim depends on how much the employee earned, how long they remain unemployed, and the state’s maximum benefit amount. The average amount paid on an unemployment claim is $4,200, but it can cost up to $12,000 or even more.
State governments get the money to pay claims by debiting the employer’s UI account (in states that require an account balance) or by increasing the employer’s UI taxes. An account balance deduction can also cause a rate increase, as it changes the relationship between taxable payroll and account balance. every claim assessed on an employer’s account may result in a tax rate increase in future years.
so the real story is not the cost of an individual claim (although it can be significant). it is the higher tax rate that will have a long-term impact.
State formulas generally use a three-year rolling period to assign a tax rate. each granted unemployment claim can affect three years of ui tax rates. employers often don’t realize the true cost of a claim since it is spread out over a long period of time.
The average claim can increase an employer’s state tax premium by $4,000 to $7,000 over the course of three years. however, it can be much more, dwarfing the cost of the claim itself. Failing to win claims can easily cost employers tens of thousands of dollars a year, if not more.
For example, let’s say an employer has a taxable payroll of $1 million and a UI tax rate of 1%. that’s $10,000 in unemployment tax premiums. after the claims on your account are assessed, the rate goes up to 5%. premiums increase to $50,000. the ui tax rate clearly makes a difference to an employer’s bottom line.
how can employers reduce unemployment costs?
Many employers view unemployment taxes as the cost of doing business. They either don’t realize that many of their former employees may not be eligible for unemployment benefits, or they don’t want the hassle of fighting claims. however, employers should avoid charges for unemployment benefits to keep their unemployment tax rate low.
This is done by contesting and winning claims when employees should not be considered eligible for benefits, such as employees who quit (in most cases) or are terminated for misconduct. Many employers use an outsourced UI claims administration/cost control company, such as U.I.S., to handle this process.
There are many proactive steps employers can take to keep unemployment costs down. This starts with smart and prudent hiring: hiring only the necessary and qualified workers. this helps prevent layoffs and situations where an employee just isn’t a good fit. careful documentation and specific, actionable feedback give employees opportunities to correct problems. being able to reverse a situation and keep a worker is beneficial for both the employer and the employee.