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Updated Oct 20, 2023

The Small Business Guide to Unemployment Insurance

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Sammi Caramela, Business Operations Insider and Senior Writer

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In life, there are moments and roadblocks we would never have predicted. No one plans for staff furloughs and layoffs, and no business owner expects to shut down their company, even temporarily. 

However, when a small business is forced to close, employees quickly become former employees. Fortunately, unemployment insurance gives your workers some financial security while they’re without income.

We’ll explore unemployment insurance and what workers and employers need to know. 

What is unemployment insurance?

Unemployment insurance came into effect nationwide as part of the Social Security Act of 1935 to assist the unemployed during the Great Depression and the following recovery. Unemployment insurance is a federally mandated and regulated program, but eligibility and payment amounts are determined at the 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 pays out to ensure the individual receives some short-term financial support.

“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 Services. “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.”

Unemployment insurance still operates much as it did at its 1935 inception. However, more rules, regulations and reports have been added over the years. Also, the unemployment division now covers payments for disability, Family and Medical Leave Act claims, workforce development, re-employment, and enforcement.

Did You Know?Did you know
Research shows that hiring managers are less likely to hire unemployed people, no matter if they've been out of work for a while or only recently quit or lost their job.

How does unemployment insurance work?

Many small business owners think they’re exempt from unemployment insurance. However, if you have employees, you’re required to pay into state unemployment insurance (SUI) and the Federal Unemployment Tax 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.”

Here’s a deeper look at SUI and FUTA:

  • SUI: SUI, also known as State Unemployment Tax Act (SUTA), is a quarterly tax that’s part of the business’s payroll taxes. The state determines the amount based on the business type and wage base. The state also considers the number of former employees who have filed unemployment claims. (A company with many former employees requesting unemployment pays a higher rate than a company with low employee turnover.) In most states, employers pay this tax, but some states require employees to contribute.
  • FUTA: Businesses also pay FUTA taxes quarterly. The employer pays all FUTA taxes; no money is taken from employee wages. FUTA 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.
Did You Know?Did you know
A wage base is the maximum amount of an employee's annual gross income that can be used to calculate the SUTA tax. This amount varies by state.

What is the process for paying into unemployment insurance?

Generally, when a company hires an employee, part of the onboarding process includes enrollment in the state and federal unemployment compensation programs. Depending on the state’s requirements, new hires are periodically reported and placed on tax rolls, but employers must report each new hire 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.”

States have varying business labor laws involving unemployment insurance and many more issues. If you're starting a new business or expanding your business to another state, ensure you research your region's laws thoroughly.

Are at-will employees eligible for unemployment benefits?

Most states have at-will employment, meaning the employee can leave or be terminated at any time for any reason. At-will employees are eligible for unemployment. The exception is if the departure is due to a disciplinary problem, such as insubordination or theft.

If you fire an employee, keep detailed documentation, which protects the company if they file a claim. “Documentation is key,” Krugel advised. “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.”

Are independent contractors and freelance workers eligible for unemployment benefits?

Employers pay SUI and FUTA for W-2 employees. W-2 employees qualify for employer unemployment insurance if they become unemployed through no fault of their own and meet the state’s work and wage requirements and any other eligibility requirements.

Independent contractors and freelance workers (W-9 workers) are generally not covered by unemployment insurance.

How does a former employee file for unemployment?

To apply for unemployment benefits, a former employee must file a claim with the unemployment insurance program in their state as soon as they become unemployed. They will need to provide some information, including their former employer, how long they worked there and the business address. Once they submit that information, it generally takes two to three weeks to receive their first benefit check.

What is a base period employer?

A base period employer is a business that paid an employee’s wages within a preestablished time frame before they filed for unemployment. When you terminate an employee who files for unemployment, you are their base period employer.

To be eligible for an unemployment claim, an employee must meet your state’s wage requirement within the base period. Local and state business regulations govern how the base period is measured. Many states use the first four of the last five calendar quarters that the employee worked for your company. 

What should you do when a former employee files for unemployment?

After an employee files a claim, the now-former employer 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: 

  • Accepting an unemployment claim: If you accept the unemployment claim request, no further action is necessary. It’s up to the state to determine if the claim meets specific criteria (such as length of service, the reason for unemployment, etc.).
  • Contesting an unemployment claim: However, if you contest the claim – for example, if you fired the employee for malicious behavior or they quit for a new job that fell through – you must inform the state why you’re contesting the claim. You’ll 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. As the employer, you have 10 days to contest the unemployment 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.

Good recordkeeping, including detailed performance reviews, is essential throughout an employee's time with your business so you can accurately address issues like unemployment insurance.

Additional resources for in-depth unemployment insurance advice

The precise steps involved with handling unemployment insurance can usually be found on your state’s website, according to Chris Orletski, president of Blankit Insurance Group. “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 advises any small business employer with unemployment insurance and tax questions to talk to an employment attorney in the state where you employ individuals. The U.S. Department of Labor also provides links to the various state departments charged with handling unemployment insurance. 

Parting advice on unemployment insurance

It can be difficult thinking about a situation where your employees are no longer on your team. It can also be challenging to understand all the taxes you owe. Unemployment insurance exists at the intersection of both these concerns. If you’ve worked through this guide, you should have all you need to make sense of SUI and FUTA. 

Isaiah Atkins contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.

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Sammi Caramela, Business Operations Insider and Senior Writer
Sammi Caramela is a trusted business advisor whose work for the U.S. Chamber of Commerce and others centers around creating digestible but informative guidance on all things small business. Whether she's discussing cash flow management or intellectual property, work trends or employer branding, Caramela provides actionable tips designed for small business owners to take their entrepreneurship to the next level. Caramela, who also lends her expertise to the financial outlet 24/7 Wall St., has business management experience that allows her to provide personal insights on day-to-day operations and the working relationship between managers and independent contractors. Amidst all this, Caramela has found time to publish a young adult novel, develop a poetry collection and contribute short stories to various anthologies.
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