There’s been an ongoing conversation in the nonprofit sector for more than four decades about state unemployment insurance. And some are wondering if the subject matter is just a bad version of Groundhog Day.
“I’m amazed that more organizations don’t take advantage of unemployment reimbursing,” remarked Alan Lesher, CFO, of YMCA of the Inland Northwest in Spokane, Washington. “You would think it’s a no brainer. It’s just another tax 501(c)(3)s don’t have to pay.”
In 1972, 501(c)(3) nonprofits were given the option to fund unemployment benefits outside of their state unemployment insurance program. Since then more than 35 percent of eligible nonprofits have begun unemployment reimbursing, but many nonprofits still pay unemployment taxes even though they could save considerable money by choosing not too.
“When you first bring up unemployment tax alternatives it’s not unusual for a CFO to ask if it is legal,” laughed Cynthia Koral, chief marketing officer for 501(c) Services – a provider of full-service alternatives to state-run unemployment insurance programs for nonprofits.
The relationship between state unemployment benefits and nonprofits is unique. That unique relationship makes legitimate unemployment insurance tax alternatives available.
“All employers share the burden of the national unemployment insurance benefit system,” explained Bo Garner, assurance manager with PBMares – a Mid-Atlantic accounting and business consulting firm. “Fortunately for 501(c)(3)s, the federal government believes that they have low turnover and allows them to elect to reimburse the unemployment system, not pay into it.”
The current unemployment system began with the Social Security Act of 1935 and has been amended a few times since its creation. Basically, how it works is that employers are charged a payroll tax that funds large state-managed benefits pools. From these pools, separated employees are paid unemployment benefits until they find new work or their benefits period ends.
An interesting feature of the unemployment insurance benefits system was added in 1972. The law was amended so that not all employers are required to pay the per-employee tax assessed by the states. One of those employer types is 501(c)(3) charities.
“Per the IRS, 501(c)(3)s are only required to reimburse for unemployment claims paid out to separated employees by the state,” explained Garner. “Yet many nonprofit executives and board members either aren’t aware of this tax option or don’t see it as a legitimate cost saving measure.”
The result of 501(c)(3)s continuing to pay the tax is massive overpayments into the state unemployment insurance system by those employers. Those overpayments are dollars that could be used for missions.
“We audit hundreds of 501(c)(3)s annually,” said Koral. “It’s been our experience that upwards of 86 percent of nonprofits who pay state unemployment taxes are overpaying.”
It’s those overpayment figures that have made nonprofit executives like Lesher advocate for nonprofit unemployment insurance reimbursing.
“That’s what really excites me about this choice nonprofit executives have,” said Lesher. “Depending on the size of an organization’s payroll and their state tax rate, we are talking about a lot of money.”
“Every organization sees relative amounts of savings,” continued Lesher. “Some save less, and some save more. I often use the example of a small agency like a local SPCA. They may only save $5,000 a year, but that equals a lot of services for a local pet community. It’s all relative.”
“I don’t think the sector is not aware of this tax strategy,” remarked Garner. “I just think everyone is extremely busy. They are constantly chasing funders, managing programs and trying to keep costs down to maximize effectiveness.”
“That’s why we remind our clients of this option and suggest they take a moment to consider the savings. Right there in their payroll taxes are funds they don’t have to fundraise for. They’re potentially just giving the money to the state. There is value in researching a cost saving option like this.”
When a 501(c)(3) decides to discontinue the paying of state unemployment insurance taxes, they have a few options to handle the new unemployment claims they will begin to receive from the state.
“Unemployment reimbursers have three options to replace the tax,” explained Koral. “They can handle the claims in-house which means they are basically self-insuring their unemployment; they can use a third-party administrator that is set up to help them manage the claims; or they can actually buy a custom insurance policy that pays the claims.”
Each option, as spelled out by Koral, has its own risks and rewards.
“The most expensive, least risky way to handle unemployment is to pay the taxes,” said Koral. “The option that returns the most money to the organization is the self-insurance option, but that option also carries the most risk. That’s why many reimbursers choose a third-party administrator or the custom insurance policy route. Through those two options, you get a good balance of savings and risk.”
When thinking about the money his organization has saved over the past decade, Lesher agrees with Garner, “Every board and CFO at a 501(c)(3) should consider doing this – at least run the numbers. It’s a fiduciary responsibility in my opinion.”
For those board members or executives that want to review the possible savings, Koral has a few suggestions, “The math is easy. Look at how much your organization has paid in state unemployment insurance taxes for the past three years. Compare that total to the actual unemployment claims you have incurred over the same period. Most nonprofits are going to see a figure they would love to have returned to their budgets.”
Garner also recommends getting the organization’s accounting firm involved, “Ask your CPA. They should be able to walk you through it all. Or contact an unemployment alternatives provider directly. They’ll run a simple audit and provide you with your options.”