Who Pays for Unemployment Benefits?

by Michael on Oct 8, 2012

Photo of Employee Termination Form with Pen and Glasses

With the unemployment rate in the news, I thought I’d take a closer look at who actually pays for unemployment compensation.

In general terms, unemployment benefits are paid through the Unemployment Insurance program, which is jointly administered between the federal and state governments.

Unemployment insurance is funded through employer-paid federal and state payroll taxes. Employers are typically required to pay these taxes if:

  1. they pay more than $1500 in wages during any quarter of a calendar year, or
  2. they had at least one employee during any day of a week during 20 weeks in a calendar year.

That being said, the requirements in some states are different, so the situation might be slightly different depending on where you live.

Federal unemployment taxes

Collection of unemployment taxes is authorized under the Federal Unemployment Tax Act (FUTA), which empowers the IRS to collect taxes (using IRS Form 940) to fund state workforce agencies.

These federal taxes also pay for half the cost of extended unemployment benefits (in cases of high unemployment) and also provide a fund from which states can borrow to cover their unemployment obligations.

As things currently stand, the federal unemployment tax rate stands at 6%. This rate is applied to the first $7000 paid to an employee during the year. This is the so-called “federal wage base”. The state wage base may be different (and probably is) depending where you live.

However… Employers can generally take a credit against their federal unemployment tax liability for as much as 5.4% of the 6% federal rate based on amounts paid into state unemployment programs. For the most part, this means that employers wind up paying 0.6% of the federal wage base.

State unemployment taxes

The details surrounding state unemployment taxes vary from one state to the next and can’t be easily summarized. There are, however, a few generalities:

  • The state wage base is frequently higher than the federal wage base
  • Rates vary within a specified range with the high end being at least 5.4%
  • These ranges vary inversely with unemployment fund balances (i.e., they go up as available funds dwindle and vice versa)

Actual contribution rates depend on the employer’s past experience. New employers pay a new employer rate, and the rate then varies going forward based on the frequency of unemployment claims by their (former) employees.

It’s also worth noting that, in three states (Alaska, New Jersey, and Pennsylvania), employees are required to contribute to unemployment insurance. We’re not talking about large sums here (0.5-1.0% of the wage base in AK, 0.3825% of the wage base in NJ, and 0-0.08% of gross wages in PA) but it’s definitely worth mentioning.

State unemployment taxes, which are paid to state workforce agencies, are used solely for the payment of benefits to eligible unemployed workers.

Summary (the tl;dr version)

So there you have it. Unemployment benefits are, for the most part, paid for by the employer in the form of federal and state payroll taxes. These payments are tax deductible for the employer.

Federal unemployment taxes, which can range as high as $420/employee (at the nominal 6% rate; these more commonly max out at 0.6% of the federal wage base), cover state workforce agencies, a portion of extended benefits, and a fund from which states can borrow to cover their unemployment obligations. In contrast, state unemployment taxes are only used to pay unemployment benefits.

Of course, one could argue that employees are really the ones paying for these benefits because they add to the total cost of employment, thereby reducing the funds available for payment in the form of salary, wages, or other benefits.

Or perhaps one could argue that consumers are the ones that are paying for unemployment benefits because companies ultimately pass these costs along to us in the form of higher prices.

Sources: US Dept. of Labor (1, 2), IRS.gov (Pub. 15)

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