In every state where an employer operates and has employees, it is required to pay particular unemployment tax rates. These rates are assigned annually and are based on the employer’s historical experience in the state. In other words, the more claims paid out, the higher the rate may be. Most states’ unemployment tax rates are effective January 1 through December 31, so employers should see these coming in droves at the moment.
As of this writing, 18 states have already mailed their 2023 unemployment tax rate notices to employers and third-party agents. Before the end of December 2022, another 25 states are set to mail these notices to employers and third-party agents. The remaining 12 states and territories will mail their 2023 unemployment tax rates between January and April, 2023.
One of the most common questions payroll and tax professionals have at this time of year is, “How can I get a lower rate?” There are 27 states that statutorily allow employers to prepay their unemployment tax in order to obtain a lower rate for the year. The term is called a voluntary contribution or VC. By prepaying the tax into their tax rate account, employers can change the ratio between their taxable payroll factor and account balance, thereby lowering their rate for the upcoming year.
For example, an employer may be able to make a VC in the amount of $5,000 which, when added to its account balance in a particular state, will change the ratio. The new ratio, when applied to the applicable rate table, will lower the tax rate. So instead of paying $500,000 in taxes for the year, the employer will pay only $400,000 because of the VC. Subtracting the VC amount from the savings amount provides the net tax reduction. This is an example for the purpose of explaining it in this communication. Sometimes a VC is profitable and other times not. But it is always a good idea to calculate the VC to make sure all tax reduction opportunities are identified.
As is common with all things unemployment tax, there are deadlines which must be met in order to make the VC and have it considered timely. Most states have a 20-day deadline which means the VC must be made within 20 days from the date the rate notice was mailed. If the deadline is missed, the VC will not be accepted by the applicable state agency. So it is imperative to identify all the states where a VC is allowed so no tax reduction opportunities are missed.
Another topic on the rise for many employers is that of a FUTA Credit Reduction. FUTA is an acronym for Federal Unemployment Tax Act. A FUTA Credit Reduction occurs when a state unemployment agency has an outstanding Title XII loan for two consecutive January 1 dates and doesn’t repay the loan before the deadline of November 10. The FUTA Credit Reduction will appear on the Federal Form 940. This means, instead of getting credit for 5.4% of the 6% tax due, employers in those states would receive a credit of only 5.1% instead.
Due to the pandemic, many states’ trust fund balances were decimated so they applied for an advance, or loan, to replenish it. There are three states and one territory which did not repay their loans by the November 10 deadline so they will have a FUTA Credit Reduction on the 2022 Federal Form 940. Those states/territories are Connecticut, Illinois, New York and the Virgin Islands. If the loans are repaid by November 10, 2023, the state(s)/territory will not appear on the 2023 Federal Form 940.
Unemployment tax rates can fluctuate drastically from one year to the next, so it is important to be aware of all tax reduction options employers may have. If your internal teams are unaware of these options or do not have time to research them, it may be a good idea to look into a third-party agent to manage your unemployment claims and tax administration.