Key Takeaways
- Federal scrutiny of unemployment insurance (UI) fraud is intensifying: in June 2026, the U.S. Department of Labor warned states to strengthen fraud controls or risk losing federal administrative funding.
- Nonprofits are not exempt from the problem: although 501(c)(3) organizations are exempt from federal FUTA taxes, they still pay state SUTA taxes (or reimburse the state directly) and can face fraudulent or mistaken UI claims.
- The scale is significant: the Government Accountability Office estimates that fraud in pandemic-era unemployment programs likely reached $100 billion to $135 billion, or 11% to 15% of benefits paid.
- UI claims involve three parties (the employer, the former employee, and the state), and state audit tools like the Benefit Accuracy Measurement (BAM) program depend on prompt employer verification, which fraudsters using stolen identities can exploit.
- Nonprofits can reduce their risk through strong recordkeeping, documented fraud-response procedures, manager and staff education on UI, and investment in digital security and identity-theft protection.
- Acting quickly on suspected fraud limits an organization’s liability and SUTA cost exposure while helping ensure benefits reach the people who need them.
The Trump administration and the Department of Labor (DOL) have made cracking down on unemployment fraud a major priority. Recent statements from the DOL have focused on state-level fraud detection and enforcement and have promised further guidance aimed at pushing states to improve their unemployment insurance (UI) systems. Some governors have pushed back on the department’s messaging as politically framed, but the underlying problem is well documented: the Government Accountability Office estimates that fraud in unemployment programs during the pandemic likely reached between $100 billion and $135 billion, which illustrates how significant the issue can be.
Nonprofits and mission-driven organizations operate under different UI rules, but this does not mean they are any less subject to fraudulent or mistaken claims. At a time when many nonprofits are working to maintain services, retain staff, and secure consistent funding, many are taking a closer look at their finances and liabilities, including UI claims. Because the unemployment insurance process involves multiple parties, even organizations that do everything right can still find themselves the victim of fraud or a mistaken claim.
Building processes and organizational awareness can help you catch these issues and take action, which not only helps you but also helps ensure that unemployment payments go to those who need them. Here’s how UI works and how you can prevent fraud:
Nonprofit Unemployment Insurance
Unemployment insurance is a combination of state and federal programs, and both the states and the federal government collect taxes to fund UI. These taxes are known as SUTA and FUTA, respectively. 501(c)(3) organizations are exempt from FUTA, but because they still pay SUTA taxes and are subject to state UI programs, they can still face fraudulent claims or mistaken payments.
Each state has a different SUTA tax based on each employee’s wages, and states also use different systems, which is why some states have a higher reported rate of mistaken payments than others. Organizations that frequently lay off employees will see their SUTA rate increase, as they place a greater cost burden on UI funds. This increase is sometimes waived because of a natural disaster or another mass-unemployment event like the recent pandemic.
The SUTA system allows nonprofit employers to pay into the state UI pool as a tax, as described above, or to opt out of these taxes and instead be liable to reimburse the state only for the specific claims their former employees make. Some nonprofits use a trust to manage UI claims and payments, as these trusts can handle the work of monitoring claim legitimacy and help them weather excessive costs.
How unemployment claims should, and shouldn’t, work
The unemployment insurance process differs slightly from state to state but generally requires input from three parties: the organization, the former employee, and the state UI system. After an employee loses their job, they are required to submit information about themselves, their employment, and the reason for their termination. Once they are certified as eligible for UI, they begin collecting from the state until they find a new source of income. Some states also require them to verify that they are actively searching for a job to continue receiving payments.
To prevent mistakes and fraud, states use the Benefit Accuracy Measurement (BAM) program, which audits a sample set of UI claims and checks their accuracy, often contacting the former employer to verify the dates and circumstances of the employee’s termination. Although this program is designed to combat fraud, it uses only a sample set and depends on prompt verification from the former employer to work well. This means it can be bypassed by fraudsters who use stolen identity information or who submit huge volumes of requests.
In addition to fraudulent actors, state systems are often under significant strain, which increases during periods of economic uncertainty or crisis. Mistakes like overpayments, payments sent to currently employed people, or misfiled claims are not necessarily malicious, but they can still cost UI programs and employers.
What you can do to protect yourself and your employees
One of the most frustrating aspects of this system is how difficult it can be to know when something is wrong. For example, say a former employee finds a job soon after being laid off, but because a fraudulent actor obtained information about their dismissal, that actor was able to collect benefits. You might not detect this issue even if a BAM auditor contacts you, since you probably would not know that your former employee had found a new job.
Catching these mistakes requires collective education and engagement. Some or all of the following can help empower you to protect your organization:
Institute strong recordkeeping practices
Keeping digital copies and records of any documents or notes related to layoffs or terminations allows you to easily double-check and verify any BAM requests, and to do so promptly. Not replying to audits can leave you liable for greater payments and higher SUTA taxes.
Develop guidelines for fraud detection and mitigation
Having a documented set of processes for your team to follow when they detect fraud is critical, as responding quickly reduces your liability and the potential costs. Each state UI program has its own fraud reporting resources, and some organizations may also report fraud to the FTC.
In addition, having notification procedures to inform former employees that they might have been the victim of identity theft protects them from other nefarious activity.
Educate managers and staff about UI
Although it can be a difficult topic to discuss, the recent federal guidelines can be a good opportunity to create guidance and documentation of the state UI process that your managers can use to follow best practices, and that helps former employees know what to do if they detect fraud.
Invest in digital safety education and resources
UI benefit fraud most often relies on some form of identity theft to make claims appear legitimate, which means that educating your team about digital safety and security best practices can help stave off these risks. Investing in digital safety classes, security audits, and tools like password managers not only protects your organization’s sensitive data but also helps your employees limit their exposure to identity theft and other crimes.
Staying ahead of unemployment fraud
Protecting your organization from unemployment fraud is not about any single fix. It comes from combining good records, clear internal processes, staff awareness, and strong digital security so that problems are caught early and handled quickly. Together, these practices reduce your liability, help keep your SUTA costs in check, and protect both your organization and your former employees. Just as important, they help ensure that unemployment benefits reach the people who genuinely need them.
About Us
For more than 40 years, 501(c) Services has been a leader in offering solutions for unemployment costs, claims management, and HR support to nonprofit organizations. Two of our most popular programs are the 501(c) Agencies Trust and 501(c) HR Services. We understand the importance of compliance and accuracy and are committed to providing our clients with customized plans that fit their needs.
Contact us today to see if your organization could benefit from our services.
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The information contained in this article is not a substitute for legal advice or counsel and has been pulled from multiple sources.
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