Nonprofit leaders know it’s critical to have a clear understanding of their organization’s financial and tax obligations—and that includes state and federal unemployment insurance taxes.
When an employee loses their job due to circumstances beyond their control, the Unemployment Insurance (UI) system steps in to offer a helping hand by providing temporary, partial income replacement while the employee searches for a new job. These benefits are funded by state and federal taxes levied on employers.
Thanks to a 1972 exemption, registered 501(c)(3) organizations aren’t required to pay state unemployment taxes. They’re only responsible for reimbursing the state for claims for which they are liable. While for-profit employers must pay into the state unemployment insurance pool, nonprofits can often save money by opting out and choosing to be billed by the state for any claims they’re liable for.
For a nonprofit employer, it’s particularly important to have a thorough understanding of the UI tax rate in order to determine if becoming a reimbursing employer could help save an organization money that would otherwise be spent on UI taxes.
Understanding FUTA vs SUTA taxes
Unemployment Insurance is a joint federal-state program, which means it’s funded by both federal and state taxes. The federal tax is commonly referred to as FUTA, and the state tax as SUTA.
Federal Taxes (FUTA)
The Federal Unemployment Tax (FUTA) supports the federal government’s oversight of state UI programs. Employers pay FUTA taxes without any contribution from employees. FUTA taxes are calculated based on the FUTA tax rate and taxable wage base. For most employers, the effective tax rate is 0.6%, but there are factors that can increase this rate, such as failing to file the federal 940 (FUTA tax return) on time or if the state in which the employer operates has a Federal Unemployment Trust Fund loan outstanding for more than 2 consecutive years. The taxable wage base is $7,000 per employee. That means most employers pay 0.6% on the first $7,000 of wages paid to employees during the year, for a total of $42 per employee.
Nonprofits are generally exempt from FUTA. However, certain types of nonprofits may be subject to FUTA tax obligations if they engage in certain business activities or have paid employees who are not exempt from FUTA taxes.
State Taxes (SUTA)
The State Unemployment Tax Act (SUTA) is a payroll tax that goes directly into each state’s UI benefit fund, from which benefits are paid out to eligible workers. Depending on the state in which a nonprofit operates, SUTA may also be referred to as State Unemployment Insurance (SUI), Reemployment Tax, or Employment Security Tax.
Similar to FUTA, SUTA taxes are paid by employers, with no contribution from employees. (Exceptions apply in New Jersey, Pennsylvania and Alaska.)
How are SUTA taxes calculated?
The federal government sets the basic rules for how SUTA taxes are calculated, but each state is allowed substantial latitude to customize the program within those rules. As a result, every state may be slightly different; what follows is a broad generalization of how the system works.
The basic principle is that the total taxes due are calculated by multiplying a company’s taxable wages by its assigned tax rate. The assigned tax rate is determined using a combination of individual experience (called “experience rating”) and the state’s need for money to fill its UI coffers (reflected in a “rate schedule”).
Each of the terms in the chart above will be defined below.
Experience Rating
Every organization is given an “experience rating,” which is typically based on individual factors such as turnover history and how well an employer handles individual UI claims.
Generally, states assign lower tax rates to employers with lower turnover rates, and higher rates to employers with higher turnover rates. If an organization’s benefit payments are disproportionately high relative to their contributions and taxable payroll, their experience rating will increase, which will in turn bump up their SUTA tax rate.
Specifically, when determining an organization’s experience rating, state UI agencies will review a 3 to 5-year history of:
- Taxable payroll
- Unemployment taxes (often called “contributions”) paid by the organization
- The total amount of benefits deducted from the tax account
In addition, in some states the experience rating process may also include shared charges from other employers, which the state has decided to reassign. This might include, for example, benefits paid out in error or due to fraud, among other reasons, which are shared among all employers in the state.
(Note on new employers: New employers do not yet have a turnover or UI payment history. They are taxed at a base rate determined by their state. These employers will receive an experience rating after they have paid UI taxes for a few years, depending on state laws.)
Experience ratings matter
It can’t be emphasized enough that the rate at which an organization lays off employees has serious—and costly—implications for the SUTA tax rate.
In Arizona for example, employers with the lowest experience rating may pay as little as $5.60 per employee. In the same state, employers with the highest experience rating pay $1,502 per employee.
In addition, although the taxable wage base is the same in most states for all employers regardless of their experience rating, two states—Nebraska and Rhode Island—also adjust the wage base for individual employers based on their experience rating. In Nebraska, for example, employers with low experience ratings pay SUTA taxes on only the first $9,000 paid to each employee, while employers with the highest experience rating pay the top UI tax rate of 5.4% on the first $24,000 paid to each employee.
Rate Schedule
A rate schedule is a table with a set of experience ratings running down the left side, and the corresponding tax rate in the right column. However, states don’t have just one rate schedule; instead, they have a series of rate schedules that they can move between.
Generally, these schedules are laid out in a grid, with columns next to each other in order of increasing tax rates. The example below shows part of the rate table for California. The left-most two columns (labeled “Reserve Ratio”) refer to the formula California uses for experience rating. The other columns give eight different rate schedules, labeled AA through F+:
Tax Rate
An employer’s tax rate is determined by looking in the row for an employer’s experience rating, and the column for the rate schedule currently in force. The intersection of the row and column will give the tax rate. For example, as shown in the California schedule above, if an employer has a reserve ratio of -0.16 and the current rate schedule is B, that employer’s tax rate will be 5.3%.
Note that with this kind of system, states can increase or decrease the taxes for everyone by shifting the rate schedule right or left, which will change the taxes for all employers even if their experience rating has stayed the same.
States frequently change the rate schedule in order to pull in more taxes (or less) in response to the health of the state fund that pays for UI benefits. This is one way for the state to compensate for shared charges that were not assigned to specific employers’ experience ratings, because if the experience ratings for a large number of employers are too low, the necessary taxes can be raised, and the cost spread among all employers by adjusting the rate schedule upward.
Taxable Wages
The final step in determining total taxes due is to determine the taxable wages. Every state has a “taxable wage base” determined by the legislature. The taxable wage base determines what portion of an employee’s wages is taxable for the purposes of UI. For example, if a state’s taxable wage base is $7,000 (the current minimum allowed), an employee who earned $50,000 per year would have the first $7,000 taxed, and the remaining $43,000 would be untaxed.
If you multiply the tax rate by the taxable wages, you get the total tax due.
SUTA Tax Rates and Taxable Wage Bases are subject to change each year
It’s common for states to change SUTA tax rates and/or taxable wage bases each year. Organizations can find a state-by-state list of 2023 unemployment tax rate changes here.
Most nonprofit organizations are overpaying SUTA taxes
Anytime an employer pays unemployment taxes with no recent history of layoffs, they are “overpaying” into the unemployment system. If a nonprofit has a long history of few to no layoffs, the result is they pay more money in taxes to their state’s UI system than they ever cost the state in unemployment claims. To put it bluntly, this means their tax contributions are funding the benefits of other employers in their state—including for-profit employers—who more often layoff staff. How can this be?
There are three common reasons why nonprofit employers are at a disadvantage in the SUTA tax system:
- Definition of “taxable wage base”: As described above, taxes are not calculated based on the total wages at a company, but rather by the first wages paid to each employee, up to the amount of the taxable wage base. This means that employers with more employees will pay more in taxes than employers with fewer employees, even if they have the same gross annual payroll in dollars.Therefore, the tax burden falls heaviest on organizations with a) seasonal hires, such as summer employees; b) part-time hires, such as in after-school programs; or c) low-salary positions such as those in the service industry. Many nonprofits fit in one or more of these categories, so they are being taxed on a higher percentage of their payroll than for-profit employers without those types of positions.
- Shared costs that affect tax rates: Every state has rules that will move some unemployment benefit costs into pools of shared expenses that all employers get charged for, even they have no control over them, such as the state’s payment of fraudulent or erroneous claims. The mechanisms vary from state to state, but generally they increase any inequities in the system by spreading costs proportional to taxes paid rather than by payroll, or by penalizing employers with good experience ratings.
- Deficits in professional claims management and education: Not everybody who files for unemployment benefits is supposed to receive them, according to the rules set up by the state; however, the burden is placed on the employer to respond to any misstatements that occur in the claim. Because this is a specialized area of knowledge, one of the keys to keeping a low experience rating is to become proficient in responding quickly and appropriately to claims. In addition, knowledge of the unemployment system can help an HR department handle separations in a way that will minimize damage to an employer’s experience rating. Many nonprofit leaders are unfamiliar with these needed business specialties.
There is an alternative to paying the SUTA tax.
Nonprofit organizations have the option to become reimbursing employers, which means they reimburse their state’s UI system for the amount of UI benefits paid to their former employees instead of paying UI taxes. This option can help save an organization money if it has a relatively low number of unemployment claims. In fact, many employers can realize potential savings of more than 20% per year versus paying SUTA.
Unlike for-profit organizations, nonprofit organizations that choose to become reimbursing employers are not at the will of fluctuating state UI rate tables and experience ratings.
In 2023, many states increased SUTA tax rates in order to help refill UI trusts that were emptied out following an increase in UI claims and fraud in the early days of the pandemic. These unemployment tax increases are expected to continue in many states in the coming years.
Becoming a Reimbursing Employer with 501(c) Services
In 1982, 501(c) Services established the first trust in the country to offer a safe way for nonprofits to legally stop paying the SUTA tax while still covering unemployment charges for former employees.
Instead of paying a flat state tax rate, 501(c) Services helps organizations build a reserve account that they own and that earns interest through sound conservative investing. 501(c) Services then monitors and handles all unemployment claims and reimburses the state for any paid claims. Our program has more than 1,300 participants and saves those nonprofits an estimated $20 million annually. Learn more and work with us.
(Photo by Pixabay)
