Small Business Questions & Answers


Filed under Managing Your Taxes

Ask About Unemployment Taxes -- Part 1

by Edgy Employer | May 20, 2012

Subject :Taxes

Dear Toolkit,

I've just this past summer hired my first employees and am beyond confused about unemployment taxes. Seems like both the state and federal governments want a pound of flesh and a raft of record keeping. Can this be right? Please clue me in if you can. If they pile many more taxes on me, I'll have to apply for unemployment compensation myself!


Edgy Employer

Dear Edgy Employer,

How right you are. . .each layer of government gets its own special reporting form and its very own payment. The Great Depression of the 1930s mandated some sort of multi-governmental action to stem the tide of rampant unemployment and a starving citizenry, and multiple unemployment taxes are the result.

The precursor legislation was the 1931 Wagner Bill that envisioned a federal-state partnership for the purpose of helping folks find jobs. Subsequent legislation over that decade, including the massive 1935 Social Security Act, provided that the federal-state partnering arrangement also be applied to giving unemployed folks something to tide them over until they found reemployment—namely, unemployment compensation!

And as we all know, when federal and state governments have to pay something out, they need to hustle up some income—namely, taxes! Thus, through this effort to provide social and economic stability during hard times, the unemployment tax was born. By 1939, all 48 states plus Alaska, Hawaii and the District of Columbia had separate administrations to manage the payment of unemployment benefits. And six decades later they're still doing their thing!

The Federal Unemployment Tax Act (FUTA) imposes a 6.2 percent payroll tax on employers, based on the first $7,000 of wages they pay to an employee in any given year. However, you can generally claim credits of 5.4 percent of taxable FUTA wages to offset any state unemployment taxes (sometimes called SUTA) you pay. This effectively reduces the FUTA tax rate to 0.8 percent. The fact that your actual state tax rate may be far below 5.4 percent doesn't matter—the federal credit is fixed at that rate. Employers are required to pay FUTA tax if they meet either of two tests.

To learn what your own state SUTA requirements are, click on the state map you'll find here. States use "experience-rating" systems to assign lower unemployment tax rates to employers whose workers suffer the least involuntary unemployment and higher rates to employers whose workers suffer the most involuntary unemployment. In other words, the fewer successful claims for unemployment benefits that your former employees file, the lower your tax rate will be.

For example, in Illinois your SUTA rate can be anywhere between .2 to 7.25 percent in 2010, depending on how efficient you are at controlling employee turnover. For a new business with no previous experience rating, a rate of 3.5 percent is initially assigned (except for the construction, mining, manufacturing and agriculture-forestry-fishing industries.) And for 2010 your rate is applied to the first $12,520 in wages for every employee per year—higher than the current federal wage base of $7,000. For 2009 the IL-SUTA wage base was $12,000.

California, on the other hand, keeps the federal base of $7,000 and imposes rates ranging from 0.1 to 6.2 percent. The starting rate for a firm with no experience is 3.4 percent.

Alaska has a much more stringent law. Rates of 1 to 5.4 percent on a base of $34,100 for 2010 apply, and there's another kicker as well. You must withhold 0.50 percent from each employee's base wages to remit to the state. Thankfully, Alaska is the only state so far to impose an employee-withholding requirement.

As you see, rules vary widely among the states, so check yours carefully. And be advised, there's more to this story—check out Part 2.