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The Basics of Unemployment Taxes

February 8, 2017

Nearly all private employers in the Carolinas are required to pay quarterly unemployment insurance (“UI”) taxes to the relevant state unemployment agency on behalf of their employees.  Like other insurance and tax obligations, UI taxes can have a significant impact on employers’ bottom line, particularly if they are not aware of the factors impacting their tax rates.

UI tax systems are designed to ensure that each employer contributes to the state unemployment trust fund in a manner consistent with its anticipated demand for payment of unemployment benefits.  An employer with a history of stable, secure employment opportunities, with few no-fault terminations, generally pays UI taxes at a lower rate than an employer with a history of more frequent no-fault terminations, since the employer providing stable job opportunities will require the agency to pay less in unemployment benefits to employees terminated through no fault of their own (the standard for entitlement to unemployment benefits).

Therefore, the biggest factor in determining an employer’s UI tax rate is its unemployment “experience,” meaning the monetary value of the unemployment benefits paid to former employees terminated through no fault of their own.  As an employer’s unemployment “experience” increases through benefit payments charged against its account, its future UI tax rate will also typically increase, in the same way that a person’s car insurance premium typically increases after an at-fault claim suggesting he or she is a riskier driver.

The second biggest factor impacting an employer’s UI tax rate is the size of its payroll.  The state unemployment agency divides the total value of the employer’s unemployment experience (dollars paid to terminated employees) by the total taxable payroll for the same time period to arrive at a “benefit ratio” for a particular tax year.  The benefit ratio determines the tax “class” or effective rate to be assigned to the employer for that year, pursuant to the tax table set by the state agency on an annual basis.  Therefore, a larger employer’s tax rate will not be affected as quickly by the payment of unemployment benefits on its behalf, since the rate is determined by a comparison of benefits charged against total payroll.

An employer’s tax rate can also be affected by a merger, consolidation, asset purchase, or similar acquisition of another business.  If two employers become a single employer through a corporate transaction, the state agency will generally combine their past unemployment experience records and payroll figures to calculate a new, single tax rate.  The post-acquisition employer may be faced with a significant, unanticipated tax burden if the acquired company had a less favorable UI tax history than expected.  Thus, employers are well-advised to consider UI taxes as an important part of their due diligence process when evaluating the potential acquisition or another business.

Of course, there is one major factor affecting UI tax rates that employers cannot control: the annual tax tables established by the state agency.  Tax rates are established annually based on the solvency of the trust fund, which accounts both for anticipated benefit payments and for other obligations that must be paid out from the fund.  Most states’ unemployment agencies, including the Carolinas’, are still repaying sizable loans obtained from the federal government to cover the surge in benefit payments arising during the financial crisis.  Tax rates vary from year to year based on the state’s assessment of the funds needed to cover both benefit and loan payments.

Ultimately, the best way for an employer to minimize its UI tax liability is to adopt effective policies and procedures for documenting disciplinary and misconduct issues prior to termination.  An employer that neglects to provide the unemployment agency with appropriate documentation to support the reasons for an employee’s termination risks the employee receiving unemployment benefits to which he or she would not otherwise be entitled, potentially resulting in a multi-year impact on the employer’s UI tax rate.  Consult your labor and employment lawyer for more information and strategies on minimizing UI tax obligations.  


Our Insights are published as a service to clients and friends. They are intended to be informational and do not constitute legal advice regarding any specific situation