The State Unemployment Insurance tax system is confusing and challenging. We get it. That’s why we’ve created this “Explore” path which breaks the information down into smaller chunks of information. We invite you to wander around to learn more about the options and benefits of becoming a reimbursing employer.
State Unemployment Insurance (SUI) 101
The Social Security Act, passed in 1935, requires for-profit employers to provide a maximum of 26 weeks of unemployment to separated employees through state-run unemployment insurance programs. States pay unemployment benefits from pools of funds they reserve for qualified unemployment benefits payouts (unemployment insurance claims). States raise these funds by levying a payroll tax (benefits premium) on most employers. What an employer pays in taxes is based on state-by-state standards that include varying tax rates, layoff histories, and taxable wages. Every year states produce a tax table with a range of tax percentages.
Every employer in the state is assigned an annual tax rate (based largely on past unemployment experience - history of layoffs – and other state and national economic factors.) The revenue collected through these state unemployment insurance (SUI) taxes (unemployment insurance premiums) are reserved and pooled together. The states use the pooled funds to cover unemployment expenses for all employees.
It wasn’t until 1972 that Social Security Act was amended to require all employers (not just for-profit employers) provide unemployment benefits. However, the amendment gave three classes of employers the legal right to manage their unemployment benefits outside of the state-run programs:
- 501(c)(3) Public Charities
- Public/Government Entities
- Tribal-Owned Businesses
Because the federal government believes that these three employer groups layoff fewer employees, they are granted the legal option to manage their unemployment outside of the state-run unemployment insurance programs. Unemployment benefits are still paid directly by the state. After the state pays benefits (claims) to an unemployed employee, it then bills the past employer(s) for reimbursement. The employer is not assessed an unemployment insurance tax (benefits premium) on their taxable payroll. They do not send funds to the state unemployment insurance pool.
Becoming a Reimbursing (pay-as-you-go) Employer
Tens of thousands of qualified employers have elected to switch status from being a merit rated employer (paying an unemployment insurance tax) to being a reimbursing employer (paying only for the unemployment claims of their separated employees). In the nonprofit sector, about 35 percent of 501(c)(3) nonprofits have made this selection and possibly a higher percentage in the public/government sector.
In all states but California, there is a once a year deadline to switch from a merit rated employer to a reimbursing employer. (See specific state deadlines here.)
To become a reimbursing employer, employers must
- File required state specific paperwork 30 days (recommended) before the state deadline;
- Secure a state-required bond. (Fifteen states require reimbursing employers to put up a security bond. See the list of bond states here.)
After the state reviews the paperwork, they notify the employer of the change and issue a new state tax identification number that indicates the new reimbursing status.
Claims Administration – How it Works
When a 501(c)(3) nonprofit decides to become an unemployment insurance reimburser, unemployment insurance claims administration becomes more important to them. Their new reimbursing status means they must only pay the unemployment claims for which they are legally liable. Every year the Department of Labor reports that billions of dollars of unemployment benefits are mistakenly paid due to fraud and error. Having a robust claims administration process becomes strategically and financially more valuable than when the employer was just paying state unemployment insurance taxes.
The internal – or outsourced – unemployment claims administration process needs to have three parts.
- First, a reimbursing employer should have reserve funds set aside to pay for all claims for which the employer is liable.
- Second, the employer should have a robust auditing process to review the unemployment claims timely and insure they have been calculated properly and are owed.
- Lastly, the employer needs access to unemployment insurance professionals who can provide the proper expertise to appeal incorrect or disputed claims.
Not having a strong unemployment claims administration process can undermine the budget savings an employer is enjoying through not paying state unemployment insurance taxes.
Benefits to Reimbursing for Unemployment
For many employers, the benefits of becoming a reimbursing employer far outweigh the risks of assuming all responsibility for unemployment claims. Some key benefits include:
- Cost Savings
- Better Financial Control
A. Cost Saving Benefit
There are three main areas where employers can realize a cost savings by becoming a reimbursing employer:
- Overpaying/Subsidizing State Pool
- Lag State Benefits
- Fluctuating State Unemployment Taxes
1. Overpaying/Subsidizing State Pool
Based on a recent analysis done of 501(c)(3) nonprofits, it was found that nearly 86% of those paying SUI taxes are overpaying. Meaning they pay more money in taxes/benefits than they ever cost the state in unemployment claims. They are therefore funding benefits of other employers in their state including for-profit employers. Employers who pay only for their own unemployment charges save money by not paying into a government pool that pays claims for everyone else’s unemployed employees.
2. Lag State Benefits
Thirty-three states are defined as “lag states” (find a list of those states here) which means during the first year after an employer becomes a reimbursing employer any claims paid out from January to (approximately) September are paid out of the employer’s original state unemployment benefits account, and not charged to the employer for reimbursement. Strategic management of this initial benefit can result in substantial one-year savings.
3. Fluctuating State Unemployment Taxes
Each state determines how their unemployment insurance benefits pool is funded. Two factors are used to calculate an employer’s contributions:
- State Taxable Wage Base
- Tax Rate Schedules
The wage bases and tax schedules are leveraged a different way in every state. Some states manage their unemployment better than others. Some states amassed huge debts during the last recession and their tax rates have remained relatively high to pay off those debts.
A few states did not enjoy the way their unemployment systems performed during that recession, so they are implementing them in new ways. This can mean unannounced changes to taxes, claims payments and taxable wage bases.
In other states, the taxable wage base is indexed to the average wage or some other method. In those states the employer will most likely see their costs continue to rise even if their tax rate decreases somewhat. Also, tax rates are based on experience. If an organization has a recent history of no-fault layoffs, their unemployment taxes will increase to match their poor claims history – regardless of state-wide unemployment.
B. Better Financial Controls
Reimbursing employers have removed their organizations from the state managed unemployment insurance program so that they can manager their own individual programs. This allows them, through tools like third party administrators and custom insurance policies, to more actively control their annual unemployment insurance liability. They are less vulnerable to evolving state economic conditions and the actions of state legislatures. The can almost to the penny know how much their unemployment insurance is going to cost them from year to year. This allows for better utilization of their entire budget.
Risks of Reimbursing for Unemployment
Opting out of the state unemployment program has many rewards, but also a few risks. The key risk that the employer is moving out of a fully insured program to assuming all the costs of unemployment benefits paid out to separated employees. Qualifying employers with high or unpredictable employee turnover are not good candidates for reimbursing as the unforeseen expenses may strain budgets and be difficult to predict. Reimbursing employers should maintain proper funding reserves to pay for unemployment claims. Proper reserves protect the employer from unexpected layoffs or a catastrophic loss of funding.
Another risk – for any employer – in either the merit/tax program or as a reimbursing employer, are erroneously claims paid out by the state and charged to employers. Every year, the Department of Labor must publish a list of those improperly paid payments. The latest published report (2017) showed a nationwide total of 3.8 billion! Closely monitoring every claim is a wise exercise for every employer.
- State Tax Reimbursing Option
- Self Insurance Reimbursing Options
- Third Party Administrator Reimbursing Option
- Custom Insurance Option
Becoming an unemployment insurance reimburser is a cost saving strategy that does carry some risk for the employer. Unemployment insurance reimbursing employers are responsible – or liable – for compensating their state tax agency for any unemployment insurance claims the agency paid out to the employer’s separated employees. Therefore, unemployment insurance reimbursing employers leverage several different strategies to manage their unemployment insurance claims. Some employers:
- Create an in-house solution to manage their claims
- Contract with a third-party administrator to manage a reserve and administer claims payouts
- Buy a custom insurance policy that pays the claims
Each strategy carries with it a different balance of unemployment insurance tax savings and risk.
State Tax Reimbursing Option
The most expensive, least risky way to manage unemployment insurance is to pay unemployment insurance taxes. By being part of the state unemployment insurance program, employers are completely protected from unexpected layoffs or catastrophic funding loses but will often pay more to the state in taxes than they will ever cost the state in unemployment insurance claims.
Therefore, many 501(c)(3) nonprofits leverage their ability to reimburse unemployment insurance benefits by utilizing one of several different strategies to manage their unemployment insurance claims. Each option carries with it a different balance of unemployment insurance savings and risk.
Self Insurance Reimbursing Option
After petitioning the state to become an unemployment insurance reimburser - a cost saving strategy that does increase the unemployment insurance claims exposure for the employer - some employers create an in-house solution to manage their claims. This “self-insurance” option can carry considerable risk. Employers become responsible for creating an in-house unemployment claims administration function and managing a proper reserve from which to pay their unemployment claims.
Aside from carrying a lot of risk, this unemployment insurance reimbursing option often provides the most unemployment insurance tax savings.
Third Party Administrator Reimbursing Option
When becoming an unemployment insurance reimburser, many employers contract with a third-party unemployment insurance solutions provider (TPA) to manage their unemployment claims function. These TPAs have programs that allow them to manage a reserve (often interest bearing), as well as audit and administer claims payouts.
The TPA option is often provided either through contracting with a for-profit solutions provider or joining a member organization – like a Grantor Trust – that provides the services under the supervision of the membership.
For many employers, this option carries a good balance of risk, administration, and savings.
Custom Insurance Reimbursing Option
After becoming an unemployment insurance reimburser, some employers purchase a custom insurance policy that pays their unemployment insurance claims. These policies are written – in consultation with the employer’s business insurance broker - in a way that allows them to know exactly what their annual unemployment insurance expenses will be. This solution allows for the most control over future unemployment liabilities.
Buying custom insurance to replace the state unemployment insurance program is the least risky of the options used by reimbursing employers and results in least amount of tax savings.
When buying custom unemployment insurance protection, it is recommended to only purchase a policy that is admitted by the state board of insurance. Doing so is an easy way to further reduce an employer’s unemployment insurance risk.
Who We Are
501(c) Services is a 100 percent employee-owned company. In 1982, 501(c) Services established the first unemployment insurance trust in the country to provide a safe way for 501(c)(3) nonprofits to legally stop paying state unemployment insurance taxes.
501(c) Services helps 501(c)(3) nonprofits legally pay only for their own unemployment claims costs. We operate, with member oversight, two of the nation’s most successful unemployment insurance trusts; the Boy Scouts of America Unemployment Plan and 501(c) Agencies Trust.
We also offer a wide-range of programs including our:
- Nonprofit HR Hotline
- 501(c) Agencies Trust Group Retro Plan for Washington nonprofits
- UInsure – a first-of-kind admitted unemployment insurance product for 501(c)(3) nonprofits
Beginning in 1982 with a dozen 501(c)(3) nonprofits, 501(c) Services began providing unemployment insurance tax alternatives to the nonprofit sector.
Since that time, we have grown to serving a network of more than 1,500 organizations nationwide. We work closely with both large national organizations such as Boys and Girls Clubs, Y-USA, Feeding America and United Cerebral Palsy as well as smaller stand-alone organizations.
We also partner with dozens of national organizations, such as 501 Commons, National Human Services Assembly and the Nonprofit Risk Management Center, to provide their member nonprofits with additional cost saving and risk management strategies.