Key Takeaways
- Nonprofits with 501(c)(3) status can choose how to fund unemployment benefits: pay state unemployment tax (SUTA) or reimburse the state for benefits actually paid to their former employees, known as reimbursing.
- Reimbursing replaces a fixed tax with actual claim costs, which can save money in years with few layoffs and cost more in years with many.
- Employees are covered either way. The choice changes who bears the cost, not whether former workers can collect benefits.
- 501(c)(3) organizations are already exempt from the federal unemployment tax (FUTA), so this decision affects state obligations only.
- Many states make the change effective only at the start of a year, set minimum commitment periods (California requires five years), and may require a bond or deposit, so the fourth quarter is the time to decide.
The fourth quarter is a good time to take stock of your organization’s progress and look at changes you might make in the new year. Nonprofits have spent several years absorbing the effects of a global pandemic, inflation, and reductions in federal funding. Leaders are looking for any change that frees up resources for the mission, however small it might seem.
That same pressure means few nonprofit leaders have time to review how they pay for unemployment. Many 501(c)(3) organizations have a choice they rarely revisit: pay state unemployment tax, or become a reimbursing employer and pay only for the benefits their former employees actually receive. In many states, a switch can only take effect at the start of a year, and once made, it locks you in for a set period. That makes it a time-sensitive decision.
Like any tax decision, it deserves careful thought. The right choice depends on your organization’s size, staffing stability, and tolerance for risk. Here are your options and what each one means.
How standard unemployment insurance works
Unemployment insurance (UI) is a joint federal and state program. Employers fund it through two payroll taxes: the federal unemployment tax (FUTA) and state unemployment tax (SUTA). Organizations with 501(c)(3) status are exempt from FUTA, though other nonprofits, such as 501(c)(4), (c)(6), and (c)(7) organizations, are not. Each state runs its own UI program, collecting state taxes and paying benefits to eligible workers who lose their jobs, and in some cases to those who quit for qualifying reasons.
When a former employee files a claim, the state reviews their past wages, employment history, and reason for separation. If they are eligible, they receive weekly payments based on their prior wages for a limited period. Because every taxpaying employer contributes to the same pool, the cost of unemployment is shared: employers with few layoffs help cover those with many.
The pandemic tested that system. Claims surged, many state trust funds were drained, and several states raised employer tax rates or added surcharges to rebuild them.
Reimbursing
Federal law gives 501(c)(3) organizations a second option. Instead of paying SUTA, they can elect to become reimbursing employers. Their employees remain fully covered. Former employees file with the state and receive benefits exactly as they otherwise would. The difference is who pays: the state bills the reimbursing employer, usually quarterly, for the benefits charged to its account. When a claimant worked for more than one employer during the period the state uses to calculate benefits, charges are typically split based on the wages each employer paid.
The appeal is straightforward. A taxpaying employer pays a set rate whether or not anyone files a claim, and that rate also helps cover other employers’ claims. A reimbursing employer pays only for its own former employees. For organizations with steady staffing and few separations, that can cost less than the tax.
The trade-off is risk. Costs follow claims, so a year with layoffs, program cuts, or a lost contract can bring large and unpredictable bills at the moment an organization can least afford them. Reimbursing employers are also billed for any improper or fraudulent claims charged to their account that go unchallenged, so responding promptly to state claim notices matters.
Some organizations prepare by setting aside a reserve to cover expected claims. In general, reimbursing fits organizations with stable staffing and predictable funding. Organizations with high turnover, seasonal staff, or uncertain funding should weigh the risk carefully.
How to change
Timing and rules vary by state. In many states, a switch takes effect only at the start of a calendar year, and the paperwork may be due weeks in advance. California is an exception: an election takes effect on the first day of the quarter in which it is filed.
States also set a minimum period before you can switch back. California requires nonprofits to stay on reimbursing for five full calendar years, and liability doesn’t end the day you leave. California holds former reimbursing employers responsible for benefits paid to their former employees for three more years. Some states also require reimbursing employers to post a surety bond or deposit as a guarantee of payment.
Before the year ends, check your state’s deadline, look at your organization’s separations over the past few years, and compare what you paid in state unemployment tax with what those claims would have cost you directly. If your staffing is stable, reimbursing, on your own or through a group trust, may lower your costs. If it isn’t, the tax may be the safer bet. Either way, making the choice on purpose beats defaulting into it.
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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