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The Small Business Guide to Unemployment Insurance

image for Tero Vesalainen/Shutterstock
Tero Vesalainen/Shutterstock
  • When an employee loses their job, unemployment insurance pays out to ensure the individual is properly supported for the time being.
  • If you have employees, you are required to pay into State Unemployment Insurance (SUI) and the Federal Unemployment Insurance Act (FUTA).
  • To apply for unemployment benefits, employees will need to file a claim with their state's unemployment insurance program.

In life, there are moments and roadblocks we never would have predicted. Take COVID-19, for instance: We are experiencing trying times, and small businesses especially are feeling the weight of the coronavirus pandemic.

No one plans to lay off staff or close their business, even if it's only temporary. However, when a small business owner shuts their doors for any reason, whether it's due to retirement or a potential recession, employees quickly become former employees. Unemployment insurance gives your workers some financial security while they're without income.

For both small business employers and employees, here is a complete guide to unemployment insurance.

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 benefits are funded through taxes employers pay on behalf of their employees. In some states, employees pay this tax. These taxes are directed to a state-controlled reserve fund. When an employee loses their job, the insurance will then pay out to ensure the individual receives some financial support for the time being.

"The employer reserve fund, which is made up of 3% to 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.

Many small business owners think they are exempt from unemployment insurance. However, if you have employees, you are required to pay into State Unemployment Insurance (SUI) and the 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.

"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."

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 reported to the IRS using Form 940. The business is taxed at 6% on the first $7,000 the employee earns, with a maximum annual pay in of $420 per employee.

Generally, when 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 [comprising] the employee's rate of pay, cost of living and other statutory factors."

Most states have "at-will" employment laws, meaning the employee can 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. "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 you think it happened and so on."

SUI and FUTA are paid only for payroll W-2 employees.W-2 employees, qualify for employer unemployment insurance as long as they are unemployed through no fault of their own and meet the state's work and wage requirements, as well as any other eligibility requirements.

If you employed independent contractors or freelance workers (W-9 workers), they are generally not covered by unemployment insurance.

(Editor's note: Under the Coronavirus Aid, Relief, and Economic Security Act, independent contractors and freelance workers are eligible for up to 39 weeks of unemployment benefits through December 31, 2020. How much a freelancer is eligible for varies depending on his or her previous income and their state's unemployment laws. Individuals who worked as independent contractors or freelance workers are encouraged to contact their state's unemployment office.)

To apply for these benefits, the first step former employees will need to take is filing a claim with the unemployment insurance program in their state as soon as they become unemployed. They will need to provide some information, such as who the former employer was, how long they worked there, the address of their former employer, etc. Once that info has been submitted, it generally takes two to three weeks before they receive their first benefit check.

After an employee files a claim, the now-former employer, i.e., you, receives a "Notice of Unemployment Insurance Claim Filed" letter from the state. If you approve the claim, the funding comes from your tax account. (If that happens, your unemployment taxes will increase.)

You can accept or contest an unemployment claim request. If you accept it, 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, the reason for unemployment, etc.).

However, if you contest the claim – say the employee was let go for malicious behavior or quit for a new job that fell through – you need to inform the state why you're contesting the claim, and you will need to provide details about the employee, including dates of service, job title, the 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. As the employer, you have 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.

(Editor's note: Under the Coronavirus Aid, Relief and Economic Security Act, laid-off workers would receive an additional $600 per week in addition to their current benefits. Further, the legislation offers an additional 13 weeks of unemployment insurance.)

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 advised any small business employer with unemployment insurance and tax questions to talk to an employment attorney in the state in which you 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 also contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.

Sammi Caramela

Sammi Caramela has always loved words. When she isn't writing for business.com and Business News Daily, she's writing (and furiously editing) her first novel, reading a YA book with a third cup of coffee, or attending local pop-punk concerts. She is also the content manager for Lightning Media Partners. Check out her short stories in "Night Light: Haunted Tales of Terror," which is sold on Amazon.