Unemployment insurance in the U.S. is facilitated through federal and state agencies that are set up to pay employees who have lost their jobs through no fault of their own. Each state has eligibility requirements to get these payments and employers must pay into their state's fund to provide benefits.
State Unemployment Tax Act (SUTA) Laws
The unemployment compensation program is based on federal law, the Federal Unemployment Tax Act (FUTA). State laws for unemployment tax are collectively called State Unemployment Tax Act (SUTA ) laws, but each state has its own law and some states might have a different name for their law.
To fund unemployment insurance payments, FUTA authorizes the IRS to collect an unemployment tax from employers to fund state workforce agencies that provide benefits to unemployed workers. Employers must pay unemployment taxes to both the federal unemployment tax system and their state system.
The unemployment compensation system is unique among U.S. laws because it's almost totally funded by employer taxes. The federal unemployment tax is paid only by employers, and only three states collect taxes from workers.
State Unemployment Taxes and Tax Rates
Each state has its own unemployment agency that runs under federal guidelines to collect unemployment taxes from employers. Individual states set their own tax rates and payment requirements for employers. State unemployment taxes are paid to the state workforce office or state department of labor.
How States Set SUTA Rates
States set their SUTA rates for different types of employers based on experience ratings. Experience is determined by the employer's fluctuation in the number of employees from one calendar quarter to the next. In Alaska, for example, the rating system is based on a specific employer's experience with quarterly wage declines (the decline in wages reported by a company from one quarter to the next).
An employer having greater fluctuation in employment (a fast-food franchise, for example) would pay the highest tax rate. Employers can get credits to reduce their unemployment tax rate for lower experience ratings.
All states have a new employer rate for the first few years, to see what the employer's experience rate will be. New employers in California, for instance, pay a 3.4% unemployment tax rate for two to three years. Then, the employer's experience rating determines their tax rate.
Covered Wages and Covered Employees
States also set SUTA tax based on wages subject to this tax and employees covered by it.
Some forms of payment are not included in some states. For example, Florida employers don't have to pay SUTA tax on the cash value of meals and lodging. Some types of employees and types of employment aren't covered, and no SUTA tax must be paid for these workers. Florida doesn't cover workers who are family members or students on internships.
Be sure your company's workers are classified correctly. If you misclassify a worker as an independent contractor instead of an employee, it may affect their ability to claim unemployment assistance benefits.
States Requiring Employee Contributions
Pennsylvania, Alaska, and New Jersey require employee contributions to their unemployment funds. Pennsylvania requires employees to pay a tax on their gross wages. Employers withhold the employee contributions and submit them with their quarterly reports to the state.
Credit Reduction States
A state may borrow from the federal government to pay unemployment benefits. These states are called "credit reduction states." (As of 2020, only the U.S. Virgin Islands has a credit reduction status.) If an employer in one of these states pays wages subject to unemployment tax, the employer must pay additional federal unemployment tax when filing its tax report and payment Form 940.
How State and Federal Unemployment Taxes Work
Employers must pay into both federal and state unemployment funds if they
- Pay wages to employees totaling $1500 or more in any quarter.
- Have at least one employee during any day of the week for 20 weeks in a calendar year, regardless of whether or not the weeks were consecutive.
The federal FUTA tax rate is 6.0% on the first $7,000 of wages subject to FUTA. This $7,000 is called the FUTA wage base. Generally, employers receive a credit of 5.4% when they file their annual federal unemployment tax report (Form 940), which results in a net FUTA tax rate of 0.6%.
Employers are entitled to the maximum credit if they pay all their state unemployment taxes on time and on all the wages subject to FUTA tax, except for credit reduction states.
The calculation is wage base x tax rate = tax payable. So, $7,000 x 0.6% = $42.
Each state has its own tax rate, as described above. The formula works the same way. For example, New York has a wage base of $11,600 and a maximum SUTA tax rate of 6.9%, so the tax would be $11,600 x 6.9% = $800.40.
Before You Register with Your State for SUTA Taxes
When you hire your first employee, you must register with your state's unemployment tax agency and begin calculating your unemployment tax rate and putting money aside from each payroll to pay unemployment taxes. Before you apply, here are some things you need to know:
- How to apply
- The wage base and tax rate, and the new employee rate
- What types of wages are subject to SUTA taxes
- What employees are covered
- How and when you must pay unemployment taxes (most states allow online filing and payment)
For More Information
You can get more information on federal unemployment taxes in IRS Publication 15. Department of Labor has a list of state unemployment tax offices. These agencies may be separate from the state agencies that pay unemployment benefits to out-of-work employees.