Who Pays Into Unemployment? Federal and State Taxes

Unemployment insurance provides temporary financial assistance to individuals who experience job loss through no fault of their own. This system is sustained through regular contributions, primarily from employers. These contributions are mandated by both federal and state regulations, establishing a funding mechanism to support workers during periods of unemployment.

Federal Unemployment Taxes

The Federal Unemployment Tax Act (FUTA) establishes a federal tax that employers pay to fund the unemployment insurance system. The standard FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee annually, known as the federal wage base. FUTA is paid solely by employers and is not withheld from employee wages.

Employers can reduce their effective FUTA tax rate by making timely payments to their state unemployment insurance programs. A credit of up to 5.4% can be applied against the FUTA tax for such payments, lowering the effective federal rate to 0.6%. This credit may be reduced in certain states, known as credit reduction states, which have outstanding unemployment insurance loans from the federal government. For example, employers in states like California and New York could face higher effective FUTA rates due to such reductions.

State Unemployment Taxes

State Unemployment Insurance (SUI) taxes represent the largest portion of unemployment funding and are primarily paid by employers, similar to FUTA. SUI tax rates and taxable wage bases vary across states. While the federal wage base is $7,000, many states set their own wage bases higher.

Most states utilize an “experience rating” system to determine an employer’s specific SUI tax rate. This system adjusts an employer’s rate based on the amount of unemployment benefits claimed by their former employees. Employers with a history of fewer unemployment claims benefit from lower tax rates, incentivizing workforce stability. New employers begin with a standard, state-determined rate before an experience rating is established. A few states, such as Alaska, New Jersey, and Pennsylvania, also require employee contributions to their unemployment insurance funds.

Purpose of Unemployment Contributions

The funds collected through federal and state unemployment taxes serve several purposes within the unemployment insurance system. Primarily, these contributions provide unemployment benefits to eligible individuals. These benefits offer temporary wage replacement to workers who have lost their jobs through no fault of their own, providing a financial bridge while they seek new employment.

State unemployment taxes are deposited into state-specific trust funds, which are drawn upon to pay out benefits. A portion of the collected funds also supports the administrative costs of state unemployment programs, including job service activities. Furthermore, federal FUTA funds can act as a backstop, providing loans to states if their unemployment trust funds become depleted during periods of high unemployment.