For more than four decades, nonprofit leaders have discussed the same question: Should we continue paying into the state unemployment insurance (SUI) tax system, or should we switch to reimbursing? For many organizations, this debate feels repetitive, with the same points raised again but with little change in practice.
Since 1972, 501(c)(3) nonprofits have had the option to opt out of paying state unemployment taxes and instead reimburse their state only for the actual unemployment claims made by former employees. Despite the availability of this federally authorized alternative, many nonprofits still pay into the state tax system. As a result, they often overspend on unemployment costs, dollars that could otherwise support their mission.
Frequently Asked Questions about Unemployment Reimbursing
Q: What is unemployment reimbursing for nonprofits?
A: It’s an alternative to paying SUI taxes. Eligible 501(c)(3) organizations can elect to reimburse their state only for the actual unemployment claims paid to former employees.
Q: Is reimbursing legal?
A: Yes. Federal law (FUTA §3309) requires states to offer 501(c)(3) nonprofits the option to reimburse instead of paying into the SUI tax system. Each state administers the election process.
Q: Why would a nonprofit choose reimbursing over paying SUI taxes?
A: Many nonprofits overpay into the state system compared to the actual cost of their unemployment claims. Reimbursing can redirect thousands of dollars back into mission-driven work.
Q: Is there a risk to reimbursing?
A: Yes, reimbursing organizations are responsible for actual claims. However, nonprofits can manage risk by using third-party administrators, purchasing stop-loss insurance, or carefully monitoring claims.
Q: Can small nonprofits benefit from reimbursing?
A: Absolutely. Even modest annual savings (for example, $5,000 a year) can be meaningful for small organizations. Larger nonprofits may save far more.
Q: How does a nonprofit elect reimbursing?
A: In most states, nonprofits must file an election form with their state unemployment agency. Timing varies, but typically the election must be made before the start of a calendar year.
Q: What should boards and executives consider?
A: Leadership has a fiduciary responsibility to explore cost-saving options. At minimum, compare your past three years of SUI tax payments against actual unemployment claims to see if reimbursing makes sense.
A Brief History of Unemployment Insurance
The unemployment insurance system was created under the Social Security Act of 1935. Employers paid payroll taxes into pooled state funds, which provide temporary benefits to employees who lose their jobs through no fault of their own.
In 1972, Congress amended the law through the Unemployment Compensation Amendments of 1970 (implemented in 1972) to give certain employers, including 501(c)(3) nonprofits, the right to choose an alternative. Instead of paying the per-employee SUI tax, nonprofits could elect to reimburse their state dollar-for-dollar for the actual unemployment benefits paid to former employees.
This adjustment was rooted in federal law, specifically Section 3309 of the Federal Unemployment Tax Act (FUTA). It recognized that many nonprofits, particularly charities, tend to have lower employee turnover and therefore did not need to pay into a system that may not reflect their actual claims experience.
Why Many Nonprofits Still Overpay
Despite this long-standing option, only about one-third of eligible nonprofits nationwide have chosen reimbursing. Participation rates vary by state, but most continue to pay unemployment taxes into the state system.
Audits and sector experience show that a large share of nonprofits paying into SUI are overpaying compared to their actual unemployment claims. For some, the unnecessary cost is modest, perhaps $5,000 a year. For others, particularly larger organizations, the excess can reach tens or even hundreds of thousands of dollars.
Every dollar paid into the state system unnecessarily is money that could otherwise support services, programs, and mission. For nonprofits operating on tight margins, this is not trivial; it’s a strategic decision that can free up scarce resources.
Is Unemployment Reimbursing Legal?
One of the most common questions nonprofit leaders ask is whether reimbursing is even legal. The answer is yes. Federal law requires every state to allow 501(c)(3) organizations the option of reimbursing. States administer the election process, which usually involves filing paperwork with the state unemployment agency and making the choice effective at the beginning of a calendar year.
More information about this framework can be found in Department of Labor guidance.
Running the Numbers
Before making the switch, organizations can run a simple comparison:
- Calculate total SUI taxes paid over the past three years.
- Add up the actual unemployment claims incurred in that same period.
- Compare the two numbers.
For many nonprofits, the difference is dramatic. Taxes paid often far exceed actual claims cost. This exercise helps board members and executives evaluate whether reimbursing could reduce expenses without taking on unmanageable risk.
The Governance Dimension: Fiduciary Responsibility
Unemployment reimbursing is not just a financial strategy; it is also a governance issue. Board members and executives have a fiduciary responsibility to consider cost-saving options that can maximize resources for mission.
Even modest annual savings can add up to a significant budget impact. For example, a small community nonprofit might save $5,000 each year by reimbursing. While that may sound modest, those funds could support additional services, expanded programming, or crucial overhead that would otherwise require new fundraising.
Options for Managing Reimbursing
Nonprofits considering reimbursing have three main ways to manage the risk of unemployment claims:
- Self-insurance (in-house management): The organization pays the state directly for claims, essentially bearing the full risk. This option provides maximum savings but also carries the highest exposure if unexpected layoffs occur.
- Third-party administrator (TPA): Many nonprofits use an administrator to help manage claims, provide expertise, and reduce risk. TPAs can ensure proper documentation, contest improper claims, and track liabilities.
- Stop-loss or custom insurance policy: Nonprofits can purchase insurance products that cover unexpected spikes in claims. This balances cost savings with risk protection, offering peace of mind to boards and executives.
Paying SUI taxes remains the most predictable and least risky option, but it is also the most expensive. Self-insurance offers maximum savings with maximum exposure. The majority of reimbursing nonprofits fall somewhere in the middle, choosing to work with a TPA or insurance product to balance savings with stability.
Why More Nonprofits Need to Evaluate Reimbursing
For many nonprofits, reimbursing is a hidden opportunity to save money without cutting programs or staff. The decision is straightforward, the analysis is simple, and the potential payoff is significant.
Key reasons to consider reimbursing include:
- Cost savings: Redirect dollars from payroll taxes back into mission.
- Legal authority: Federal law guarantees this option for 501(c)(3)s.
- Flexibility: Multiple management options allow organizations to balance risk and savings.
- Governance responsibility: Boards and executives have a duty to evaluate cost-saving measures that improve organizational sustainability.
Taking the Next Step
Nonprofits interested in exploring reimbursing should:
- Review their SUI tax history and unemployment claims.
- Consult with their accounting firm or auditor.
- Reach out to providers specializing in unemployment alternatives for nonprofits.
Even if an organization ultimately decides to remain in the tax system, evaluating the numbers is a fiduciary best practice. For those that do make the switch, the savings can directly support mission-driven work.
Conclusion
Unemployment reimbursing is not a new idea. It has been available to nonprofits for more than 40 years. Yet many organizations overlook it, effectively donating excess funds to the state when they could be reinvesting those resources into their communities.
By taking a closer look at the reimbursing option, nonprofit leaders can ensure they are maximizing every dollar entrusted to them. For some, it may be a modest adjustment. For others, it could be transformative. Either way, it’s an option every 501(c)(3) board and executive team should seriously consider.
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.
Are you already working with us and need assistance with an HR or unemployment issue? Contact us here.
The information contained in this article is not a substitute for legal advice or counsel and has been pulled from multiple sources.
(Images by EyeEm and Katemangostar)
