More on unemployment taxes from a reader question

In an earlier message, I discussed the three types of payroll taxes S corporation owners pay.

I lumped both federal (FUTA) and state (SUTA) unemployment tax into one category:

Unemployment Both the federal and state governments impose unemployment taxes. Only the employer (your business) pays this (although a few states and localities impose an employee-paid unemployment tax). These usually amount to about 6% of the first $7,000 salary paid (or $420) per employee per year. -

Reader Chris asked the following (shared with permission):

Related to S-corps, if the owner is not required to pay SUTA, is 6% FUTA still required? If so, where would they claim these benefits if needed (as would not be registered with the state)? -Chris

Let’s unpack this question by digging into unemployment insurance (UI).

Federal law—the Federal Unemployment Tax Act (FUTA)—requires each state to administer and pay unemployment benefits. These benefits provide cash payments to individuals on a weekly basis after losing a job and meeting certain eligibility requirements. Those who quit or were fired for a just cause do not qualify.

The FUTA tax rate is 6.0%, and the base—the amount on which that rate applies—is the first $7,000 paid to each employee. This means your FUTA liability is up to $420 per employee per year.

But each state also imposes unemployment tax (known as SUTA or SUI). The calculations at the state level tend to get more complicated.

States have different SUI tax rates. In fact, many states determine rates on a company-by-company basis. Your company’s SUI rate can depend on the age of the business, your industry’s turnover rate, and the number of former employees who have filed unemployment claims.

In 2022, several states had a minimum SUI rate of less than 0.01%. Arizona tops the chart with a maximum rate of 20.93%. Most employers pay around 2–5% SUI rates.

Most states use the reserve ratio method to determine each employer’s rate. This starts with unemployment taxes paid minus benefits paid to former employees, and divides that figure by the employer’s average annual payroll. Companies that pay less into UI, have more former employees collecting benefits, and running smaller payrolls pay higher rates. This helps shift the burden toward businesses that produce more demand for UI benefits.

States have different SUI tax bases. Although the federal unemployment tax base is $7,000, each state can determine its own base. Several also use $7,000, but many have larger bases.

For 2022, Washington state tops the list with a SUI tax base of $62,500. Most employers pay less than 1% on that base though, so it’s important to keep both numbers—rate and base—in mind when comparing states.

SUI payments earn a credit toward FUTA. Employers pay SUI throughout the year, usually monthly or quarterly; however, they pay FUTA just once, annually. This allows the FUTA calculation to take SUI payments into account.

As long as your company pays its SUI in full, on time, and the state isn’t determined to be a credit reduction state, when calculating FUTA, you generally receive a credit of up to 5.4% of FUTA taxable wages, reducing the FUTA liability to just 0.6% of the first $7,000 paid to each employee, or $42.

NB Credit reduction states are those that borrowed federal funds for unemployment benefits. If the state does not repay those funds on time, the FUTA credit for SUI tax paid is reduced slightly. You can find a list of credit reduction states by clicking here.

Now that we have a better understanding of how unemployment insurance works, back to Chris’s questions.

First, if the owner is not required to pay SUTA, is 6% FUTA still required? Probably, as the FUTA liability is reduced by the SUI paid. If no SUI was paid, then there would be no reduction in FUTA.

Second, if so, where would they claim these benefits if needed (as would not be registered with the state)? This gets trickier to answer.

Non-owner employees should still be eligible for unemployment benefits, depending on their situations. Because each state has a different process for determining eligibility and qualification for benefits, it would depend.

As for owners, many states exempt businesses with only owners as employees—typical for a small S corporation—from paying SUI. This usually means the owner is not eligible for benefits if she becomes unemployed by her own business.

Before you think is unfair, remember: an S corporation is a federal tax election. Most states still view S corporation owners as self-employed and do not go out of their way to make employment-based benefits available to them.

COVID temporarily changed that thinking, though. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted in March 2020, made self-employed workers—independent contractors, sole proprietors, and even S corporation owners—potentially eligible for UI benefits. The American Rescue Plan Act (ARPA), enacted in March 2021, extended this through September of 2021.

Thanks to Chris for the questions!