How-to guide: How to comply with the unemployment insurance program (USA)

Introduction

This guide will assist in-house counsel and private practice lawyers with understanding the unemployment insurance program that is in place in the United States. This guide sets out the key issues to address and points to consider when determining an employer’s legal obligations with regard to employee compensation under the unemployment insurance program.

This guide covers:

An overview of the unemployment insurance program
Financing requirements for the unemployment insurance program
Employee rights to unemployment compensation

This How-to guide can be read in conjunction with How-to guides: Overview of US employment law and Checklists: Determining the difference between an employee and an independent contractor and Terminating the employment of an at-will employee.

Section 1 – An overview of the unemployment insurance program

Unemployment insurance (UI) is a state-provided insurance that pays individuals unemployment compensation (UC) as a weekly benefit when they experience job loss, provided the individual meets certain eligibility requirements. Note that UI is a separate program to workers’ compensation. Workers’ compensation is a program that requires employers to carry insurance that compensates employees for injuries sustained at work (see How-to guide: Dealing with workplace injuries for further information on workers’ compensation).

1.1 Purpose of the UI program

The purpose of UI is to provide temporary and partial income replacement to individuals who have lost their jobs through no fault of their own. The program provides a vital safety net, offering financial assistance to help maintain a basic standard of living while individuals are seeking new employment.

1.2 Federal-state partnership

The UI program is a joint initiative between individual state governments and the federal government.

UC to eligible, unemployed individuals is made available through the Federal Unemployment Tax Act (FUTA) and state employment agencies. Each state has a department that administers its own program within national guidelines promulgated under FUTA. Employers are required to pay into both the federal and state funds, with credits available to offset the federal component for state taxes paid.

The Unemployment Trust Fund maintains separate UI accounts for each state, the District of Columbia, the Virgin Islands, and Puerto Rico, who deposit their respective unemployment taxes into their accounts and withdraw funds to cover UC payments made to eligible individuals.

1.2.1 Federal Unemployment Tax Act

The Federal Unemployment Tax Act (FUTA) was passed in 1939 and established a payroll tax on employers that works with state unemployment systems to fund UI.

The tax is 6% of the first $7,000 that each employee makes in a year. Once the employee’s earnings reach $7,000 during a given year, the employer no longer pays any FUTA for that year with respect to that employee. Also, the employer is responsible for the full amount of the tax, unlike similar payroll taxes.

Example

Assume ABC Co paid Alan $10,000, Bob $8,000, and Cathy $5,000 last year. ABC Co would owe taxes of $420 for Alan (maximum taxable wage of $7,000, $420 for Bob (maximum taxable wage of $7,000), and $300 for Cathy (6% of $5,000).

There are exceptions for certain wages that are not considered as taxable wages under FUTA (eg, wages from a 501(c)(3) tax-exempt charitable organization).

When filing and paying FUTA tax employers are entitled to certain credits that reduce the amount of FUTA tax due, including in particular a credit based on taxes paid into state unemployment systems, as set out at 1.3 below. See 26 USC section 3302(a) and 20 CFR Part 606.

FUTA taxes paid by employers are held in the federal Unemployment Trust Fund. Each state has a separate account within the Fund to use to pay UC benefits.

Payment timescales

FUTA taxes due from the employer must usually be deposited at the end of the month following each quarter-end. For example, for the first quarter ending March 31, FUTA taxes would be due for deposit by April 30. In addition, the Internal Revenue Service (IRS) requires all federal tax deposits to be made via electronic funds transfer (EFT). Employers must also prepare and file Form 940 at the end of the calendar year. This form reports total wages paid, taxable wages paid, taxes due for the year, and tax deposits made by the employer. This form may be filed electronically (see IRS webpage: E-file employment tax forms). Should the employer need to correct a previously filed Form 940, the IRS now also offers the option of filing an amended Form 940 electronically.

1.2.2 State Unemployment Tax Act

In addition to paying applicable FUTA taxes, employers fund state UI programs through the State Unemployment Tax Act (SUTA).

Each state uses its own formula to determine the taxable wage base and salary subject to tax. The minimum state wage base allowed must equal the federal base of $7,000 per employee.

State rates may start with the minimum rate for new employers, and then the state will assign a tax rate to an employer based on the employer’s experience rating (see 2.3 below) that may go up or down each year. Employers then claim a credit against federal UI taxes based on amounts paid to their state funds.

Some example provisions from states include:

California: Minimum tax rate 1.5% (new employer rate 3.4%), maximum tax rate 6.2%, wage base $7,000.
New York: Minimum tax rate 2.1% (new employer rate 4.1%), maximum tax rate 9.9%, wage base $12,800.
Illinois: Minimum tax rate 0.75% (new employer rate 3.65%), maximum tax rate 7.850%, wage base $13,916.
Florida: Minimum tax rate 0.10% (new employer rate 2.7%), maximum tax rate 5.4%, wage base $7,000.

1.3 Tax credits

Several credits against the FUTA tax are available to certain employers.

1.3.1 Normal tax credit

Generally, employers may take a credit against the FUTA tax (see IRS webpage: FUTA credit reduction) for amounts paid into state UI funds. The maximum credit is 5.4% of FUTA taxable wages, reducing the FUTA tax rate after credit to 0.6%. Employers are entitled to the maximum credit if all state UI taxes were paid in full, on time, and on all the same wages as are subject to FUTA tax.

This 5.4% tax credit may be reduced in cases where the state has taken loans to pay UC due but fails to repay them according to statutory requirements. When a state has outstanding loan balances on January 1 for two consecutive years and does not repay the full amount of its loans by November 10 of the second year, then the FUTA credit rate for employers in that state will be reduced until the loan is repaid by the state. The credit is reduced by 0.3% for the first year the state is a credit reduction state, an additional 0.3% for the second year, and then an additional 0.3% for each subsequent year that the state has not repaid its loan in full.

1.3.2 Additional tax credits

Some employers may receive an additional credit if they have a ‘state experience rate’ lower than 5.4% (0.054), even if their rate varies during the year (see IRS webpage: Instructions for Form 940).

‘State experience rate’ refers to a tax evaluation tool used by state UI programs that sets unemployment tax rates according to the amount of UC drawn by an employer’s former employees. Rates vary from 0.0% to 8.0%. The additional credit is the difference between the employer’s actual state UI tax payments and the amount required to be paid at 5.4%.

1.3.3 Special credit for successor employers

Employers may be eligible for a credit based on the state UI taxes paid by a predecessor. The credit may be claimed for a successor employer who acquired a business from a predecessor who did not meet the definition of an employer for FUTA purposes and, therefore, was not required to file Form 940 for the tax year. See 26 USC 3302(e).

Section 2 – Financing requirements for the unemployment insurance program

Employers should gain an understanding of their obligations under the UI program, both at a federal and state level, in order to ensure UI taxes are paid in full and on time.

2.1 Financing the UI program

The UI system is financed through payroll taxes paid by employers.

At a state level, UI taxes fund:

UC paid in the particular state; and
the state share of the extended benefits program, which provides up to 13 additional weeks of benefits to workers who have exhausted regular UC when a state is experiencing high unemployment.

Federal UI taxes fund:

the administration of the state UI programs referred to at 1.2.2;
loans to insolvent states; and
the federal share of extended benefits.

2.1.1 Employer liability for FUTA purposes

Determining whether an employer is subject to FUTA tax requires consideration of whether it would fall within the general test, household employer test, or the agricultural employers’ test.

General test

There are two criteria to determine whether an organization (or individual employer) is subject to FUTA tax. An organization only needs to satisfy one of the two listed below to be subject to FUTA.

The organization paid at least $1,500 in wages during any calendar quarter in the current or previous year (a calendar quarter is January through March, April through June, July through September, or October through December).
The organization had at least one full-time, part-time, or temporary employee for at least some part of a day in any 20 or more different weeks in the current or previous year.

Household employers’ test

Anyone that pays wages to employees who perform tasks in or close to the employer’s home might be categorized as a household employer. Household employers must pay FUTA when a household employee earns $1,000 or more in any quarter and the work is performed in a private home, college club, or fraternity. Household employers can file FUTA taxes on Form 1040’s Schedule H instead of Form 940.

Agricultural employers’ test

Agricultural employers have different criteria. FUTA tax collection and reporting are required if the employer meets either of the following conditions:

they paid monetary wages of $20,000 or more to farmworkers during any calendar quarter in 2024 or 2025; or
they employed 10 or more farmworkers during at least some part of a day (whether or not at the same time) during any 20 or more different weeks in 2024 or 20 or more different weeks in 2025.

2.1.2 Employer liability for state taxes

While states will generally follow the federal framework for UI taxes, each state is given discretion in certain matters including which employers are subject to tax, wage bases, and tax rates. Employers should contact the applicable state agency for specifics in any given state (see DoL webpage: State Labor Offices).

Employers with employees in multiple states can use the Department of Labor’s (DOL) guidance for multi-state employees to determine which state to remit tax to. Each of the following must be considered:

localization of services (where the employee works most of the time);
the employee’s base of operations;
place of management, direction, and control;
the employee’s state of residence; and
whether the states in question have reciprocal agreements.

In practice, the employer must usually pay UI taxes in the state where the employee works and performs services most of the time. Some states have reciprocal agreements with nearby states, allowing employers to choose the state of coverage.

2.2 Advances from the federal Unemployment Trust Fund

In order to understand the relationship between FUTA taxes and state UI, employers should note the following ways in which the two may interact and the potential impact of this upon employers.

2.2.1 Advances

When UC being paid by a state to its unemployed residents exceeds SUTA taxes being collected from employers, states may temporarily lack the funds necessary to pay UC. In this circumstance, the state may take an advance/loan from the federal Unemployment Trust Fund.

2.2.2 Credit reduction states

When a state has outstanding loans from the Unemployment Trust Fund on January 1 for two consecutive years and does not repay the full amount of its loans by November 10 of the second year, it becomes known as a credit reduction state and the FUTA credit rate for employers in that state will be reduced until the loan is repaid.

The result being that an employer in a credit reduction state is subject to a higher tax due on the Form 940. For example, an employer in a state with a credit reduction of 0.3% would only be eligible for a FUTA credit of 5.1% (the standard 5.4% credit minus the 0.3% credit reduction) for an effective FUTA tax rate of 0.9% for the year.

2.3 Experience ratings

State UI programs operate much like a commercial insurance program in that the tax system is experience rated. While employers start with an initial ‘new employer’ rate of tax, the rate will thereafter vary depending on the amount of UC paid out over a specified time period. To the extent that an employer has a high rate of layoffs or other events resulting in reduction of their workforce (and consequent payment of UC to its former employees), the employer’s tax rate will go up based on that experience.

As is the case for a commercial insurance program, when a high rate of claims are made on an employer’s account, it is deemed higher risk and so the tax rate goes up. Conversely, an employer that has few claims is viewed as lower risk and is rewarded with a lower rate.

2.3.1 Federal requirements

The federal general principles of experience ratings set out the conditions under which states may adjust rates of contributions payable by employers to their unemployment funds.

The experience of all employers subject to contributions under a state law must be measured by the same factor throughout the same period of time.

2.3.2 State requirements

The DOL has approved a number of methodologies, including those listed below, that states may use to measure an employer’s unemployment risk.

Reserve Ratio Formula – the most common experience rating formula, which operates as a cost accounting system. Elements considered are the amount of payroll, contributions, and UC paid to employees.
Benefit Ratio – this system is simply the ratio of UC charged divided by the employer’s payroll, providing an index for rate variation.
Benefit-Wage Ratio – the ratio is the total amount of wages paid to employees who drew UC over the previous three years, divided by the employer’s total payroll over the same period. The factor for the employer is multiplied by the state experience factor.
Variations in payroll – merely considers increases or decreases in payroll.

2.3.3 State taxable wage base and rates

When an employer has a history of terminating large numbers of employees (eg, plant closures), the UI system is designed for them to pay more in SUTA taxes. The higher tax can be achieved by either an adjustment to the tax rate, or base, or both.

In Nebraska, for example, the wage base and the tax rate are both adjustable depending on an employer’s experience rating. While most employers pay UI taxes on the first $9,000 paid to an employee, employers with the highest experience ratings pay the top UI tax rate (5.4%) on the first $24,000 paid to an employee.

Section 3 – Employee rights to unemployment compensation

3.1 Eligibility for unemployment compensation

Unemployment compensation (UC) is available without a means test to unemployed individuals. All employees whose employers contribute to or make payments to state UI funds are eligible if they become involuntarily unemployed and meet certain eligibility requirements. Workers who meet these eligibility conditions may still be denied benefits if they are found to be responsible for their own unemployment.

Note that employers are not required to pay UI taxes for payments made to independent contractors, so independent contractors are typically not eligible for UC. See Checklist: Determining the difference between an employee and an independent contractor for more information on differentiating between employees and independent contractors.

3.1.1 Wage requirements

An employee’s monetary UC (known as monetary benefits) is based on wages earned during a prior reference period, called the ‘base period,’ and these rights remain fixed for a ‘benefit year'.

In most states, the base period is the first four quarters of the last five completed calendar quarters preceding the claim for UC. A number of states specify a flat minimum amount of base period earnings to qualify, while other states express their earnings requirements in terms of a multiple of the UC for which the individual will qualify (such as 30 times the weekly benefit amount).

Most states impose an additional requirement that wages are earned in more than one calendar quarter or that a specified amount of wages are earned in the calendar quarter other than that in which the individual had the most wages. Other states simply require that base period wages total a specified multiple (eg, one and one-half times the claimant’s high-quarter wages).

3.1.2 Employee requirements

Most states have special requirements that specifically restrict the UC rights of certain individuals, such as students who are considered not available for work while attending school. Federal law also restricts UC eligibility of some groups of workers under specified conditions, such as school personnel between academic years, or professional athletes between sports seasons.

3.2 Disqualification from UC

The basic premise that every individual must meet before drawing UC is to show that they are out of work through no fault of their own. There are many reasons why an unemployed worker seeking UC may be denied. Common reasons, provided by the DOL, for denial include those listed below.

The employee voluntarily left work without good cause.
The employee was discharged for misconduct connected with work. Misconduct is an intentional or controllable act or failure to take action, which shows a deliberate disregard of the employer’s interests. See, for example, Connecticut’s ‘Misconduct Disqualifications from Unemployment Compensation'.
The employee was not able to work or was not available for work. A discharged employee must be able, ready, and willing to accept a suitable job. In general, ‘suitable work’ means a job that offers compensation similar to their past employment, and is reasonably in line with their education and prior work experience.
The employee refusing an offer of suitable work.
The employee knowingly making false statements to obtain benefit payments.

Note that each state has separate rules for UC claims. Most mirror the list above.

3.3 Computing unemployment compensation

How UC is computed will vary from jurisdiction to jurisdiction. Generally, there must be some minimum base period wages earned, and there is some minimum and maximum weekly UC amount for workers deemed to be eligible for UC. See, for example, California, Texas, and Florida.

3.4 Other available benefits programs

3.4.1 Unemployment compensation for federal employees (UCFE)

The UCFE program provides unemployment compensation to federal employees that lose their employment through no fault of their own. UCFE is administered by the states (and the District of Columbia, Puerto Rico, and the United States Virgin Islands) who act as agents of the federal government. The state where the ex-federal employee had their last official duty station in federal civilian service will determine eligibility for UCFE benefits. The result is that the same terms and conditions that apply to individuals eligible for regular state UC will also apply to UCFE claimants.

3.4.2 Unemployment compensation for ex-service members (UCX)

The Unemployment Compensation for Ex-servicemembers (UCX) program provides benefits for eligible ex-military personnel, as well as former members of the National Oceanographic and Atmospheric Administration (NOAA). As is the case with other UI programs, it is administered by the states as agents of the federal government.

Persons that were on active duty with a branch of the US military may be entitled to benefits based on their service provided they were separated from military service under honorable conditions. The law of the state where the claim is filed will dictate benefit amounts, number of weeks benefits can be paid, and other eligibility conditions.

3.4.3 Trade readjustment allowances (TRA)

Trade readjustment allowances are income support payments for individuals who have exhausted regular UC and whose jobs were affected by foreign imports. Whether the individual’s job was affected by foreign imports must be determined by a certification of group coverage issued by the DOL.

Benefits paid to eligible persons include paid training for a new job, as well as job search or relocation assistance.

3.4.4 Short-term compensation (STC)

Sometimes an employer may be experiencing a reduction in work available to employees. In these circumstances (eg, economic recession) Short-Time Compensation (STC), also known as work sharing or shared-work program, is an alternative to layoffs for employers. Unlike normal UC, the STC application process is not initiated by employees, but instead by an employer who must submit an application to the appropriate state agency and the state must approve the employer’s application or plan for employees with reduced hours.

Employees must first be eligible for ‘regular’ UC in order to qualify for STC. While receiving UC benefits under an STC plan, employees are not required to meet availability or work-search requirements. They are, instead, required to be available for their normal workweek. In addition, employees who are eligible to participate in an employer’s STC plan may be required by most states to serve a mandatory non-paid ‘waiting week.’

3.4.5 Disaster unemployment assistance (DUA)

Individuals who have lost their employment (or self-employment) as a direct result of a major disaster may be entitled to Disaster Unemployment Assistance (DUA) financial assistance. This benefit is reserved for those individuals that are not eligible for regular UC.

Upon declaration of a major disaster by the president, DUA will aid any unemployed worker or self-employed individual who lived, worked, or was scheduled to work in the disaster area at the time of the disaster and is unable to work due to the disaster. Additional eligibility criteria requires that the individual:

no longer has a job or a place to work; or
cannot reach the place of work; or
cannot work due to damage to the place of work; or
cannot work because of an injury caused by the disaster.

Further, an individual who becomes the head of household and is seeking work due to the death of the former head of household may also qualify for DUA benefits. Head of household is a term typically used by the IRS and whether a person is a head of household is determined according to the Qualifying Person Test, and Cost of Keeping up a Home Test.

Additional resources

Department of Labor, ‘About Unemployment Insurance’
Department of Labor, ‘A Comparative Analysis of Unemployment Insurance Financing Methods’
Department of Labor, ‘How Do I File for Unemployment Insurance?’
Internal Revenue Service, ‘Topic No. 759 Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return – Filing and Deposit Requirements’

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Unemployment benefits