Unemployment Taxes

Businesses hit hard by the recession during the past two years are in for the tax system’s version of a follow-up sucker punch in 2010. In 35 states, the rate for unemployment taxes will rise (automatically, in most cases) due to the heavy toll absorbed by the state trust funds for the payment of unemployment benefits. Their trust fund balances and current rates of tax are insufficient to cover their ongoing costs for unemployment compensation (UC). Because the UC benefits constitute a legal entitlement, the states must continue to pay the benefits even if they don’t have the money.

The states collected an aggregate of $ 31.0 billion in state unemployment taxes in federal fiscal year 2009. During the same time period they spent more than double the amount approximately $ 75.0 billion on regular UC benefits and $ 4.1 billion on extended UC benefits.

To meet their UC benefit obligations, half the states are already borrowing from the Federal Unemployment Account (FUA) within the federal government’s Unemployment Trust Fund (UTF). These states owe more than $ 26 billion to the account as of December 29, 2009. They will continue to rack-up more debt in 2010, and several additional states will join them in borrowing from the FUA during the coming year. States with loan balances outstanding as of December 29, 2009 are: Alabama, Arkansas, California, Connecticut, Florida, Georgia, Idaho, Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, South Dakota, Texas, Virgin Islands, Virginia, and Wisconsin.

Increase in state unemployment tax rates. Ultimately the states will have to pay the piper. Not only will the state have to repay the FUA, they must continue to pay ongoing UC benefits, too. Increasing the state unemployment tax on employers is the only way to achieve this. The Congressional Research Service reports that a recent survey conducted by the National Association of Workforce Agencies found that 35 states expect an unemployment tax increase in 2010. In most states, the tax increases automatically as a result of the reduced trust fund balances. The higher rates will remain in effect (in most cases for a number of years) until the federal funds are paid back and the state trust funds have been adequately replenished.

Increases due to experience rating. Some businesses will fell the effects of a double-whammy. In addition to an across-the-board increase in the state rate, they will be hit with an experience rating adjustment that will increase their taxes even more. State unemployment tax rates are experience-rated, meaning that employers pay a higher or lower tax rate based on the experience they have with former employees making UC claims. The employers attributed with a higher percentage of UC claimants relative to the number of employees they have are subject to the higher rates. If a business has laid-off a higher than normal percentage of its employees in the recent past, it is likely to be socked with an experience rating increase. The rate ranges vary from state to state, with minimums ranging between 0 and 1.9 percent and maximums ranging from 5.4 to 10.96 percent. In many states, an employer can have a dramatic increase in the rate of unemployment tax as the result of a bad year in which layoffs were made.

Increase due to federal credit reduction. If you are unfortunate enough to be in a state that has not paid back the FUA in a timely fashion, you may pay an even higher unemployment tax rate. Michigan is the only state in this situation currently, but others may follow later in 2010. If a state does not repay the entire balance of its FUA loans by November 10 following the second consecutive January 1 on which the state has an outstanding balance, then the federal tax credit is reduced for employers in the state. The credit is reduced retroactively to the preceding January 1. That means employers will pay increased amount of federal unemployment tax (FUTA). Normally, employers pay 0.8 percent net FUTA because of the 5.4 percent credit allowed for state unemployment tax paid. However, each consecutive year a state is late in repaying funds borrowed from the FUA, the credit is reduced by 0.3 percent, thus increasing the net FUTA payable for the year by 0.3 percent.

For example, Michigan began borrowing from the FUA in 2007. On November 10, 2009, it still had outstanding FUA loan balances. Therefore, retroactively for all of 2009, employers in Michigan lost 0.3 percent of their tax credit and must pay 1.1 percent instead of 0.8 percent net FUTA for 2009. In 2010, their net FUTA will be 1.4 percent. In addition, they may be subject to a 2.7 add-on credit reduction which will result in even higher federal taxes.

While Michigan is the only state currently subject to credit reductions, it is possible that Indiana and South Carolina will join the party come November 10, 2010, and several other states that began borrowing from the FUA in 2009 could be affected in 2011.

All in all, employers thinking that the painful impacts of the recession on employment are in the rearview mirror may have another thing coming. The impact will be felt for a long time to come in higher unemployment tax rates as a result of automatic rate increases caused by reduced trust fund balances, experience rating increases resulting from higher than normal layoffs, and increases in FUTA resulting from states’ inability to repay loans from the FUA in a timely fashion.

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