What Does an Unemployment Claim Cost an Employer?

Many people mistakenly believe that unemployment insurance (UI) benefits come from a fund paid into by employees—like Social Security or Medicare. However, it’s employers who are financially responsible for unemployment benefits, and the costs are far higher than just the amount of a claim.

First, it helps to understand how unemployment insurance is financed.

Unemployment is almost entirely funded by employers. Only three states—Alaska, New Jersey and Pennsylvania—assess unemployment taxes on employees, and it’s a small portion of the overall cost.

Unemployment is funded, and taxed, at both the federal and state level:

• The Federal Unemployment Tax Act (FUTA) tax is imposed at a flat rate on the first $7,000 paid to each employee. The current FUTA tax rate is 6%, but most states receive a 5.4% “credit” reducing that to 0.6%. There is no action an employer can take to affect this rate. Some of this federal money is used for loans to states that don’t have enough in their UI trust funds to pay claims. If the loans are not repaid, the federal government raises that state’s employer tax rate.
• The State Unemployment Tax Act (SUTA) tax is much more complex. Employers pay a certain tax rate (usually between 1% and 8%) on the taxable earnings of employees. In most states, that ranges from the first $10,000 to $15,000 an employee earns in a calendar year.

Here’s where it gets tricky. Each state has its own finance method and its own calculation to determine the tax rate an employer pays. You can read about that here. For the purposes of this article, know that the tax is based on the employer’s taxable payroll, the amount the employer has paid into the UI system, and unemployment claims against the employer’s account (called “benefit charges”).

This is called an experience rating, and it can go up or down over time depending on the employer’s payroll and history with unemployment claims.

The real cost of unemployment claims: increased tax rates.

The cost of an individual UI claim depends on how much the employee made, how long they remain on unemployment, and the state’s maximum benefit amount. The average amount paid out on an unemployment claim is $4200, but can cost up to $12,000 or even more.

State governments get the money to pay claims by debiting the employer’s UI account (in states that require an account balance) or by raising the employer’s UI taxes. A deduction in the account balance may also cause a rate increase, as the ratio between taxable payroll and the account balance changes. Each claim assessed to an employer’s account can result in a tax rate increase in future years.

So the real story isn’t the cost of an individual claim (though it can be significant). It’s the higher tax rate that will have a long-term impact.

The state formulas generally use a three-year moving period to assign a tax rate. Each awarded unemployment claim can affect three years of UI tax rates. Employers often don’t realize the real cost of a claim since it’s spread out over a long period.

The average claim can increase an employer’s state tax premium $4,000 to $7,000 over the course of three years. However, it can be far more, eclipsing the cost of the claim itself. Not winning claims can easily cost employers tens of thousands of dollars annually, if not more.

For example, say an employer has a million dollar taxable payroll and a UI tax rate of 1%. That’s $10,000 in unemployment tax premiums. After claims are assessed to its account, the rate goes up to 5%. Premiums rise to $50,000. The UI tax rate clearly makes a difference to an employer’s bottom line.

How can employers lower unemployment costs?

Many employers view unemployment taxes as just the cost of doing business. They either don’t realize that many of their former employees may be ineligible for unemployment benefits, or they don’t want the hassle of fighting claims. However, employers must prevent UI benefit charges in order to keep their unemployment tax rate low.

This is done by contesting and winning claims when employees should be judged ineligible for benefits, such as employees who quit (in most cases) or are fired for misconduct. Many employers use an outsourced UI claims management/cost control company, like U.I.S., to handle this process.

There are many proactive measures that employers can take to keep unemployment costs low. This starts with smart and prudent hiring—hiring only workers who are needed and qualified. This helps prevent layoffs and situations where an employee is simply not a good fit. Careful documentation and specific, actionable feedback give employees opportunities to correct problems. Being able to turn around a situation and keep a worker is a win-win for both employer and employee.