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An increasing number of unemployment claims and rising unemployment insurance rates can pose a serious threat to any company’s bottom line. Depending on the state factors, company size, and unemployment claims history, unemployment taxes cost businesses thousands of dollars per year. In addition to this, with unemployment rates higher than ever during COVID-19, unemployment compensation costs can be even a greater cause for concern.

No matter the size of a business, handling unemployment claims is daunting and time-consuming. However, improper management can lead to serious consequences, including higher insurance rates and hefty penalties. Thus, it is important for employers to understand their obligations when it comes to unemployment compensation costs and steps they can take to control them.

How Does Unemployment Compensation Work?

Unemployment compensation is a benefit paid to people who have recently lost their job via no fault of their own. To be eligible, employees must meet specific criteria, such as working for a minimum stipulated period and actively looking for a job.

Unemployment compensation provides partial income replacement for a defined length of time or until the worker finds employment, whichever comes first. This system is jointly managed by the federal government and each individual state government.

Generally speaking, unemployment compensation provides up to 26 weeks of benefits and, on average, replaces about half of a worker’s previous wages. However, every state sets its own requirements and rules surrounding its unemployment benefits.

FUTA and SUTA Tax Rate

The unemployment insurance program is almost always funded by employer contributions through the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). These are payroll taxes that are based on a percentage of employees’ earnings, and most businesses have to pay these taxes. Also, in most states, only employers pay unemployment taxes, but three states also require employee contributions to unemployment compensation: Alaska, New Jersey, and Pennsylvania.

The FUTA tax rate for 2022 is 6.0% on the first $7,000 in wages per employee each year. However, employers generally receive a 5.4% FUTA tax credit reduction when they file their Form 940, Employer’s Annual Federal Unemployment Tax Return, resulting in a net FUTA tax rate of 0.6%.

On the other hand, the SUTA tax is much more complex. It is calculated on a percentage of each worker’s earnings up to a wage limit that varies by state. SUTA rates are calculated and can change annually based on state-mandated factors and/or employer experience factors. To determine the SUTA rate, each state has its own calculation, which looks at historical figures, up to five years in some states. If the employer’s experience, or rather claim activity, is high, chances are the tax rate will subsequently be high. Corporate structure changes may also have an impact on a company’s SUTA rates.

Factors Impacting Unemployment Compensation Costs

The number of workers who collect unemployment benefits during the lookback period is the primary factor behind the SUTA tax rate. Therefore, the fewer workers who collect unemployment benefits, the lower unemployment compensations costs will be.

One way to keep the SUTA tax rate lower is to reduce employee turnover, and there are several steps employers can take to help retain workers:

Another way to potentially lower unemployment compensation costs is the proper handling of layoffs. For example, if employers choose to pay severance for departing employees for a certain period of time, this can eliminate or reduce the amount of time they will collect unemployment benefits and, as a result, improve employers’ experience during the lookback period. Also, employers need to document everything when terminating employees for cause, as they are typically not eligible to collect unemployment. A proper paper trail that demonstrates employees’ misconduct, such as violating a company policy, increases the likelihood that their claim for unemployment benefits gets denied.

Minimizing Unemployment Compensation Costs

While unemployment taxes can be costly and challenging for businesses, employers need to make accurate and timely payments on both a federal and state level to avoid further financial consequences to their company. Furthermore, since each state has its own way of managing UI claims, they have to keep track of UI laws and compliance requirements, especially if they operate in multiple states.

Taking all of this into consideration, the most effective way to reduce unemployment compensation costs is to outsource unemployment claims management. This way, employers can make sure they are up to date with evolving regulations, as well as keep UI claims to a minimum. In addition to managing and handling incoming claims, a proper unemployment claims management service can help employers audit claims history and maintain accurate records.


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