What is Unemployment Tax?

C. Mitchell

Unemployment tax is a tax obligation borne by most United States corporations, and is an integral part of the U.S. unemployment social benefit program. All U.S. businesses that maintain a regular roster of employees are generally required by law to pay a certain amount of money each year to the national government as well as to their state governments to fund government benefits for unemployed citizens. These payments are called "unemployment taxes." The amount a company owes is assessed based on the number of employees the company maintains, the average employee salary, and the company's location. Unemployment tax is only levied against companies, and is never deducted from employee paychecks.

The Unemployment Tax funds employment benefits.
The Unemployment Tax funds employment benefits.

Each state and territory within the U.S. provides unemployment benefits to out-of-work citizens and residents in certain circumstances. These benefits are typically distributed as a paycheck would be, and are designed to keep unemployed workers afloat as they look for new jobs. Each state has its own unemployment benefits distribution system that is funded in part by in-state businesses, and in part through a national funding structure. All of the money in both programs is collected through the unemployment tax.

The amount of unemployment insurance tax collected by a state is used to pay unemployment benefits to a worker.
The amount of unemployment insurance tax collected by a state is used to pay unemployment benefits to a worker.

Companies typically have two separate unemployment tax obligations: one to the national government, and one to their state in which they are primarily incorporated. The federal unemployment tax is mandated by the Federal Unemployment Tax Act, or FUTA. Funds paid into the FUTA are used to administer the unemployment benefits divisions of the states. Some FUTA tax funds are also sent to a “reserve” account that any state can draw upon if the state’s unemployment benefits accounts are unable to meet the payout demand.

State unemployment tax collection directly funds state unemployment benefits in most cases. Each state offers slightly different benefits and services to unemployed citizens. Federal tax acts require the provision of some baseline services, but how much farther a state wants to go is usually a matter of local legislative discretion. The precise amount an unemployed worker can recoup, the duration of the benefits, and any conditions placed on payout are typically matters of state, not federal, law.

Unemployment tax rates are set by law and applied with a broad brush to all in-state businesses. A company does not usually have to pay more or less based on how much it uses or is perceived to use the unemployment system. For example, a company that terminates large numbers of people every year usually pays the same amount of unemployment tax as a similarly-situated company that retains all of its employees.

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