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A Small Business Guide to Unemployment Insurance

image for Tero Vesalainen/Shutterstock
Tero Vesalainen/Shutterstock

No one plans to lose their job. However, when a small business owner closes their doors because of retirement, relocation or poor sales, employees quickly become former employees. Unemployment insurance gives your employees some financial security while they look for a new job. 

There is a lot of confusion surrounding unemployment insurance, such as who pays for it, who is eligible, and if you can opt out of providing this benefit. Our guide answers questions about unemployment insurance, the tax implications for small businesses and how the process works. 

Unemployment insurance came into effect nationwide as part of the Social Security Act of 1935 as a way to assist the unemployed during the Great Depression and its recovery. It is a federally mandated and regulated program, but eligibility and payment amounts are determined at a state level. 

In most states, unemployment insurance is funded through taxes employers pay on behalf of their employees. (In some states, employees pay this tax directly). These taxes are directed to a state-controlled reserve fund. 

"The employer reserve fund, which is made up of 3-7% of an employee's gross wages, depending on the individual state, is backed by a reserve fund controlled by the state," said Jim Bell Sr., founder and CEO of Abel HR. "If that fails, the federal government lends money to ensure unemployed workers are paid. All businesses must pay into unemployment insurance, except for certain nonprofits." 

The concept of the original unemployment insurance benefit continues to operate in a similar manner as its 1935 inception; however, over the years, more rules, regulations and reports have been added. Also, the unemployment division now covers payments for disability, Family and Medical Leave Act claims, workforce development, re-employment, and enforcement. 

"One of the biggest misconceptions held by many business owners and managers is that unemployment insurance is a fixed, uncontrollable tax," said Bell. "This concept could not be further from the truth. Unemployment insurance costs can be controlled from the moment a business starts." 

Many small business owners think they are exempt, but if you have employees, you are required to pay State Unemployment Insurance (SUI) and Federal Unemployment Insurance Act (FUTA). All business sizes and types follow the same steps in paying SUI and FUTA, and handling unemployment claims. There are no exemptions for small businesses. 

For businesses, SUI is a quarterly tax that is part of the business's payroll tax. The amount is determined by the state based on the type of business you operate and a wage base. Also taken into consideration is the number of ex-employees who have filed for unemployment claims. (A company with a high number of former employees requesting unemployment pays a higher rate than a company with low turnover.) In most states, this is an employer-only paid tax, but some states require employees to contribute. 

FUTA taxes are also paid quarterly and are in addition to SUI. FUTA taxes are paid completely by the employer; it is not taken from employee wages. These taxes are filed through the IRS on Form 940. The company is taxed at 6% on the first $7,000 the employee earns, with a maximum annual pay-in of $420 per employee. 

SUI and FUTA are paid only for payroll W-2 employees. Independent contractors and freelance workers – W-9 workers – are not covered by unemployment insurance, and organizations do not need to pay SUI or FUTA taxes. 

When the contract ends with independent workers, they cannot file for unemployment. If they do, it can be contested. However, it is also up to the organization to ensure that all employees are labeled properly. If an independent worker can prove he was or should have been a payroll employee, the employer must pay back taxes and other penalties. 

Generally, whenever a company hires an employee, part of the new-hire process includes enrollment in either the state, federal or both unemployment compensation programs. Depending on the state's requirements, new hires are periodically reported and placed on tax rolls, but each new hire must be reported to the state. 

"Subsequently, each time an employee has payroll taxes deducted from each paycheck, some of that money is used for the unemployment compensation insurance pool," said Charles A. Krugel, a human resources attorney and counselor. "Depending on the state where the employer or employee is located, benefits-eligible people will receive biweekly or monthly payments based on a formula based mainly on the employee's rate of pay, cost of living and other statutory factors." 

Most states have "at-will" employment laws, meaning both the employee and the employer can either leave or be terminated at any time for any reason that is not illegal. At-will employees are eligible for unemployment. The exception is if the departure is due to a disciplinary problem, such as insubordination, theft and other serious charges. 

If you terminate an employee, keep detailed documentation that protects the company if a claim is filed, denied and challenged. "Documentation is key," Krugel said. "When documenting [an employee's conduct], businesses should write up incidents as soon as they occur. That is, document who was involved, who witnessed what, where events occurred, when events occurred, what happened, why do you think it happened and so on." 

An employee can file for unemployment if they lose their job through no fault of their own (i.e., they were laid off). After they file, the now-former employer will receive a "Notice of Unemployment Insurance Claim Filed" letter from the state. If the claim is approved, the unemployment funding comes from the employer's tax account. (If that happens, your unemployment taxes will increase.) 

You can accept or contest the unemployment request. If it is accepted by the employer, no further action is necessary on your part. It is then up to the state to determine if the claim meets certain criteria (such as length of service, reason for unemployment, etc.). 

However, if the employer contests the claim – say the employee was fired for malicious behavior or quit for a new job that fell through – the state must be informed of the reasons why the claim is being contested with details about the employee, including dates of service, job title, reason for termination, and any notes or reports from the employee's personnel record. 

Good record-keeping, including detailed performance reviews, is essential throughout the duration of an employee's time with your business. 

The employer has 10 days to contest the claim or risk an increase in unemployment tax. When unemployment insurance is granted, the average compensation period nationally is 26 weeks, but each state determines the length of compensation time

The steps involved with handling unemployment insurance can usually be found on each state's website, according to Chris Orletski, co-president of Blankit Insurance. "This is becoming an online process whereby the employer uploads the required information to the state, but, again, an employment attorney would be able to advise appropriately." 

Orletski also advised any employer with unemployment insurance and tax questions to turn to an employment attorney in the state which you intend to employ individuals. The Department of Labor also provides links to the various state departments charged with handling the unemployment insurance for that state."The overall takeaway is that unemployment insurance is not handled by insurance agencies but by a state governmental agency."

Sue Marquette Poremba

Sue Marquette Poremba is a freelance writer based in State College, Pennsylvania. She primarily covers cybersecurity and emerging technology, with an emphasis on how emerging technology and cybersecurity overlap.