Due to the COVID-19 pandemic, many states have had record unemployment numbers that resulted in the need to take federal unemployment loans, which can have a cost for employers if the loans are not repaid.
The December 2020 numbers from the U.S. Bureau of Labor and Statistics (BLS) on national unemployment noted that 45 states and the District of Columbia had jobless rate increases from one year earlier, no doubt due to the coronavirus (COVID-19) pandemic. States like California, Hawaii, and Nevada registered unemployment rates at or above 9% in December 2020 and throughout the pandemic, many other states suffered record-high unemployment rates rendering the state’s unemployment trust fund insolvent.
When this happens, a state borrows federal unemployment dollars to keep its unemployment fund solvent and to continue paying benefits to unemployed workers. If these loans are not repaid within a certain amount of time, the Federal Unemployment Tax Act (FUTA) tax rate credit that most employers enjoy begins to be reduced (see Payroll Guide ¶4075).
FUTA tax credit.
The FUTA tax rate is currently 6.0% on the first $7,000 in wages per employee each year. However, employers generally receive a 5.4% FUTA tax credit reduction when they file their Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax Return), resulting in a net FUTA tax rate of 0.6%.
FUTA credit reduction.
If a state has an outstanding federal unemployment loan balance on January 1 for two consecutive years, and does not repay the full amount of its loans by November 10 of the second year, the FUTA credit rate for employers in that state is reduced until the loan is repaid. The reduction schedule is 0.3% for the first year the state is a credit reduction state, another 0.3% for the second year, and an additional 0.3% for each year thereafter that the state has not repaid its loan in full.
Great Recession FUTA credit reductions.
During the Great Recession, a number of states had to take federal unemployment loans that took years to repay, which resulted in a FUTA tax credit reduction where employers ultimately paid FUTA tax at a higher rate. California was the last U.S. state to repay its loans after several years with an outstanding balance. The U.S. Virgin Islands is currently the only U.S. tax jurisdiction with an outstanding federal unemployment loan balance. Employers paid FUTA tax at a rate of 3.0% in 2020 and the Virgin Islands is already estimated by the U.S. Department of Labor to be a FUTA credit reduction state in 2021 if it does not repay its loans by November 10, 2021.
FUTA credit reductions in 2022.
As of January 28, 2021, 18 U.S. states and the U.S. Virgin Islands have outstanding federal unemployment loans. These states include California, Illinois, Massachusetts, New Jersey, New York, Ohio, Pennsylvania, and Texas, which are all states ranked among those with the largest economies in the country. If these loans are not repaid in 2022, up to 18 states could become FUTA credit reduction states for that tax year. The IRS’s Schedule A (Form 940) (Multi-State Employer and Credit Reduction Information) lists the annual FUTA credit reduction states and the DOL also provides a list each year after November 10.
Adding it up.
The total FUTA tax per employee if the full tax credit is in place is $42. If a state becomes a FUTA credit reduction state in 2022, employers will pay another $21 per employee in the tax. This may seem like a small amount, but it can add up for larger employers that have many employees. In addition, some states also pass on the cost of federal unemployment loan interest on to employers in the form of an assessment or surcharge.
During the COVID-19 crisis, state governments have taken measures to assist employers such as not charging employer unemployment tax accounts for unemployment benefits paid to workers for COVID-19 related reasons. It is unclear at this point if states and the federal government will entertain measures to avoid imposing additional taxes on employers like the FUTA credit reduction if the state’s reason for taking the federal unemployment loans was due to COVID-19, but it will be something to monitor as 2022 approaches.
