The Unemployment Compensation tax is unique in that it's not the same for everyone. It is a variable rate of taxation. And there are all sorts of things you can do to vary the rate you pay. In fact, once a year, in about half the states, you can simply write a check to your state, and BUY a lower rate. This strategy may save you many times more than what it costs. It's that easy.
The key is knowing when it's right for you, planning for the expenditure (which is usually pretty modest), and then doing it in a timely manner. This article will tell you how this works.
About two thirds of the states use a Reserve Ratio method to determine the Unemployment tax rate you will have to pay. Over the years, you pay far more into the Unemployment system in taxes than what anybody ever collects in benefits. This excess builds up into a Reserve Account. Your taxes build your Reserve account up. The Benefit Charges assessed to your account detract from it. The Reserve can build up to be millions of dollars over the years.
You can't actually tap this account, yourself. It's a virtual account; not a real thing. But the State can tap this money. If there are Benefit Charges assessed to your account, the State pays them to the claimant and charges this account. So it's like a checking account that you pay into, but the State writes the checks. States prefer this Reserve Account method of calculating taxes because it means that they don't have to put the money up front for the benefits they pay out. You have already paid the money.
Each State wants this Reserve to be at least a certain size in relation to the size of your work force. That will give them a cushion the right size for the liability for charges which they face with you. So what they do is simply divide the size of your Reserve by the average of your Taxable Wages. This division yields what is called your Reserve Ratio. This ratio is applied to a table to determine what rate you will pay. Once you reach the required ratio of cushion to liability, you will be paying the minimum rate. Most states require a Reserve equal to about six to ten percent of the annual average taxable wages. (Pennsylvania requires 25%)
Now, the key to all this is the fact that these Reserve Ratios are applied to Tables. A table is a funny thing. You don't always fall in the middle of a table range. You can just as easily fall pretty close to a threshold, on one side or the other. A small adjustment would have changed your rate.
Let's say, for example, that your Annual Average Taxable Wages are $400,000. Adding in what you paid in taxes this year, subtracting out what is charged against your account, you know you will have a new Reserve Account Balance of $19,999 at the end of this rating period. Dividing 19,999 by 400,000 will derive your Reserve Ratio. It will be just barely under 5%. Consulting your state tables, you see that 4.5% to 5% Ratios pay at 2.2%, but 5% Ratios pay at only 2.7%. That's a difference of 0.3%, which applied to your $400,000 taxable wage base would have saved you $1200 in tax liability, if only you had exceeded a 5% ratio.
No problem. Sometime between now and when your new Tax Rate Notice comes from the State, you simply take four quarters out of your pocket and a penny out of the crack between your seat cushions and mail them to the State. Now you exceed 5%. You pay the lower rate. This is called a Voluntary Contribution to your Reserve Account.
Is this a terrible unbusinesslike way for states to run their affairs? Well, let's see: You are out one buck. They are out twelve hundred bucks. Yes, I think so. But that's the way they do it.
Here are the states where Voluntary Contributions are permitted: AZ, AR, CA, CO, IN, KS, KY, LA, ME, MI, MN, MO, NE, NJ, NM, NY, NC, ND, OH, PA, SD, WV, WI
Remember that everything in the Unemployment systems has a tight time limit. The Voluntary Contribution is no exception. The time limit differs from state to state. So figure out your strategy after the rating period has ended, but before the new rate notice comes, then beat the deadline.
Some states will even advise you what you need to kick in to get a lower rate. I have seen where the State of Ohio, on its Tax Rate Notice, once advised an employer to contribute a mere $1.65, which yielded over $3800.00 in tax savings. And they printed this right on the rate notice! But most states will not go that far. In nearly every case, you have to figure it out for yourself. You will have to be able to predict what certain key elements will be at the end of this fiscal rating period. Here are the key elements:
- What will your Annual Average Taxable Wages be? Each state bases their calculation on the first so many dollars of each employee's wage. That's the taxable wages. In some states, this may be as low as $7,000. In Hawaii, it's presently $26,000! That's the amount of an employee's wages on which you pay the tax. Then you need to know how many years are averaged in your state. Now you can calculate what your average will be.
- What will your Reserve Account be? Take your previous reserve at the end of last rating period. Back out all charges. Add in all taxes That's your new Reserve. (Beware: in a few states, only a portion of your taxes actually count toward your Reserve.)
- Divide average benefits by average taxable wages to get your new Ratio
- Look where you fall on the tables. If what you have to pay to get a lower rate is substantially less than what you would save by having a lower rate, then the Voluntary Contribution is for you.
If you need help calculating whether a Voluntary Contribution is right for you, or for for help with any number of other Unemployment Tax Reduction Strategies, remember this important on-line resource. Gather up all your information, then drop a line to us using this link. Be sure to mention a day and time when you are certain that you can be available by phone.