Understanding Unemployment Insurance

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Understanding Unemployment Insurance

The unemployment compensation (UC) system — also referred to as unemployment insurance (UI) — is designed to temporarily compensate workers who lose their jobs through no fault of their own (as determined by applicable state law). UC is triggered when unemployment was brought about by periods of involuntary termination or periods of economic decline. However, in order to be eligible for benefits, unemployed workers must demonstrate workforce attachment that is usually measured by the individual’s previous amount of wages and weeks of work. Additionally, a jobless worker must be capable and available for work opportunities. Eligibility for unemployment insurance, benefit amounts, and the length of time benefits are available are determined by the state law under which unemployment insurance claims are established.

Established by the Social Security Act of 1935 (SSA), the UC system is a combined federal-state partnership. Although each state designs its own UC program, the program must be designed within the framework of the federal requirements. As a result, the varying state programs are often quite different and have different impacts on employer profits. Nonetheless, employers who pay UC taxes to a state with unemployment laws in compliance with federal requirement are usually offered tax credits against federal taxes.

If a state law meets minimum federal requirements under the Federal Unemployment Tax Act (FUTA) and Title III of the SSA, both of the following apply:

  • Employers receive up to a 5.4 percent basic and additional tax credit against the 6.2 percent federal unemployment tax.
  • The state is entitled to federal grants to cover all necessary costs of administering the UC program.

Note: FUTA, federal, and state income tax rates are subject to changes annually. Employers should consult with the Internal Revenue Service (IRS) or other applicable legal entity for current rates and scheduled changes.

Federal Law

The FUTA imposes a payroll tax on employers based on the wages paid to their employees. All states finance UC primarily through contributions from covered employers on the wages of covered workers. Additionally, three states (Alaska, New Jersey, and Pennsylvania) collect contributions from employees. These taxes are deposited by the state to its account in the Unemployment Trust Fund (UTF) in the Federal Treasury, and are withdrawn as needed to pay benefits.

Covered Employers

An employer must pay FUTA tax if any of the following occurred during the current or preceding calendar year:

  • The employer had at least one employee work for some part of any day in each of at least 20 calendar weeks. The weeks need not be consecutive and the one employee need not be the same individual. For this requirement, a calendar week is a period of seven successive days beginning with Sunday and ending at the end of the following Saturday. Short weeks at the beginning or end of a calendar year are, however, counted as calendar weeks.
  • The employer paid wages totaling at least $1,500 in any calendar quarter.
  • Employers in agriculture who had at least 10 workers in each of at least 20 calendar weeks in the current or preceding year or a cash payroll of at least $20,000 during any calendar quarter.
  • Employers in domestic service who had a cash payroll of at least $1,000 in any calendar quarter.

With exception, taxable wages are all remuneration from employment in cash or in kind. The exceptions include earnings in excess of $7,000 in a year, and payments related to retirement, disability, hospital insurance, or similar fringe benefits.

Covered employers are liable for the FUTA tax for the entire calendar year and for the next calendar year.


Although the extent of state coverage is greatly influenced by the federal statute, each state is, with a single exception, free to determine the employers who are liable for contributions and the workers who accrue rights under the laws. The exception is the federal requirement that states provide coverage for employees of nonprofit organizations, services performed for Indian tribes, and employees of state and local governments, even though such employment is exempt from the FUTA.

Computing the Tax

The FUTA tax rate is 6.2 percent of taxable wages. The tax applies to the first $7,000 paid to employee as wages during the calendar year. However, the FUTA provides a credit against federal tax liability of up to 5.4 percent to employers who pay state taxes on time under an approved state UC program. Such credit is allowed regardless of the amount of the tax paid to the state by the employer. Accordingly, in states meeting the specified requirements, employers pay an effective federal tax of 0.8 percent or a maximum of $56 per covered employee per year. State law determines individual state unemployment insurance tax rates.

The FUTA tax is imposed on a single flat rate on the first $7,000 of wages paid to each employee. Once an employee’s wages for the calendar year exceed $7,000, the employer has no further liability for that employee during that particular year. Employers who fail to pay the state unemployment tax on time are limited to only 90 percent of the tax credit amount that would have been granted if the taxes were paid on time. However, if an employer deposits all FUTA tax when due, the employer may be granted an extension for filing.

Note: FUTA tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity for current rates and scheduled changes.

Experience Ratings

Experience rating is the system under which employers are assigned tax rates in accordance with their individual experience with unemployment and subject to the needs of the state program.

Within the limitations of the general federal requirements, the experience rating provisions of state laws vary greatly.

Presently, federal law permits both of the following:

  • Reduced rates (rates below the 5.4 percent standard or basic rate) for employers with at least one year of experience with respect to unemployment or other factors bearing a direct relation to unemployment risk.
  • Reduced rates (no less than one percent) for newly covered employers on a reasonable basis.

Additional credit is allowed only with respect to a year in which the rate of the taxpayers in the state with the least favorable experience is at least 5.4 percent.

Note: Experience ratings and state income tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity for current rates and scheduled changes.

Formulas Used for Rate Determination

Federal and state laws define which employers are liable for unemployment taxes and which employees have UC protection. All state laws provide for a system of experience rating under which individual employers’ contribution rates vary from the standard rate on the basis of their experience with the amount of unemployment encountered by their employees. The experience-rating provisions of state laws vary considerably, and the number of variations increases with each legislative year. The most significant variations arise from differences in the formulas used for rate determination.

Experience is measured by the variable relative incidence of unemployment among workers of different employers. Differences in such experience represent the major justification for differences in tax rates, either to provide incentives for stabilization of employment or to allocate the cost of unemployment.

The following formulas are currently used to determine experience ratings, although a few states combine the formulas:

  • Reserve-ratio.
  • Benefit-ratio.
  • Benefit-wage-ratio.
  • Payroll-decline.

Although the formulas are different, they share the following similarities:

  • All formulas are devised to establish the relative experience of individual employers with unemployment or with benefit costs.
  • All formulas have factors for measuring each employer’s experience with unemployment or benefit expenditures.
  • All formulas compare the employer’s experience with a measure of exposure (for example, payrolls) to establish the relative experience of large and small employers.
State Tax Accounts and Experience Ratings

Generally, any employing unit, as defined by state law, must make quarterly tax payments (contributions) based on the taxable wages they report to the state unemployment agency. These monies are deposited into an Employer Trust Fund with the U.S. Treasury, designated solely for UC and readily available to the state in which the wages were reported.

All employers must establish an unemployment tax account in each state in which they do business. The state agency develops an unemployment experience for each tax account by compiling records of taxable wages reported quarterly, tax contributions, and unemployment claims experience.

Experience ratings calculations are the state’s method for measuring each employer’s unemployment experience.

Each year, employers are assigned a specific tax rate based on their overall experience in comparison to other tax-paying employers in the state and the health of that state’s Employer Trust Fund.

The critical component in determining any employer’s experience is the amount of unemployment benefits that employer has paid to its former workers. Usually, tax rates are calculated by using employers’ unemployment claims experience in comparison to reported wages.

Actual state tax rates are assigned according to these ratios and the prevailing tax schedule for the state. Employers should regularly review the state law requirements regarding these matters.

A state unemployment account is like an employer having a checking account, and employers should reconcile each assigned tax rate annually. Employers must balance their own records with the state-calculated tax rate to protect themselves from an improperly assigned rate, which is a frequent occurrence. Discrepancies should be protested in writing to the issuing authority by the prescribed deadline.

Benefit Periods

Most states currently pay a maximum of 26 weeks, although Massachusetts and Washington pay 30 weeks. In periods of very high and rising unemployment in individual states, benefits are payable for up to 13 additional weeks (20 in some cases), up to a maximum of 39 weeks (or 46). These extended benefits are funded on a shared basis — approximately half from state funds and half from federal sources.

Controlling Unemployment Costs

It is essential that employers make every effort to control their UC costs because these costs may easily erode an employer’s profits. To successfully control unemployment taxes, employers must understand all facets of the tax calculations and have knowledge of and comply with the administrative processes for the state(s) in which the employer has employees. Employers must, therefore, assign the responsibility for managing their UC control to individuals with power to take necessary action. Unemployment cost control must be a deliberate effort, based upon internal methods of investigation and response and consistent with prevailing state laws and regulations.

Eliminating Employee Separations

The ideal way to control UC costs is to keep employees working.

Employers can minimize employee separations by using good and consistent personnel practices including, but not limited to, the following:

  • Provide Well-Written, Detailed Job Descriptions. Clear and well-detailed job descriptions will minimize confusion about the scope of the job and inform a prospective employee of an employer’s expectations. A good job description will also help the employer identify the qualifications needed to fill a particular position.
  • Require a Completed Application Form. Employers should require all candidates to affirm, through their signatures, that the information they provide is true and accurate. Whenever possible, each applicant’s qualifications, experience, and references should be verified.
  • Test Applicants when Appropriate. If specific skills are required for certain jobs (such as telephone skills and word-processing skills) employers should apply uniform testing of each applicant for the positions. Employers must keep records of tests as documentation of the hiring process.
  • Offer an Information Orientation Session. New hires should receive a standard orientation session, uniformly applied to all new hires, which provides employees with all the information necessary to quickly become a productive member of the company. Employers should keep a record of those who attend the orientation sessions, verified by the employee’s signature, including the dates and times they attended. Such documentation demonstrates that new hires were immediately notified of the employer’s expectations, policies, and rules.
  • Provide Workplace Rules and Employee Handbooks. Employers must establish and communicate specific workplace rules and personnel policies. Such policies are one of the best ways to protect an employer’s state unemployment experience from unnecessary benefit charges. In a disputed unemployment case where the claimant was discharged for violating a rule, policy, or procedure, the employer must usually prove that the employee was adequately informed of the employer’s expectations.
  • Issue All New Employees an Employee Handbook. The best way to be certain employees are aware of the rules, policies, and procedures is by issuing each new employee an employee handbook. Employees should be required to verify in writing that they have received the handbook and have become familiar with the company’s policies. Changes or updates to the handbook should be distributed in writing to each employee, and employees must be required to acknowledge, again in writing, that they have received and are familiar with any change in rules, policy, or procedure.
  • Implement New Employee Performance Appraisals. Employers must determine whether a new employee meets the standards and expectations of the job during the employee’s initial period of employment. If the employee fails to meet the employer’s standards, the employer should consider the following:
    • The employee should be counseled regarding specific deficiencies.
    • The employee should be directed as how to correct those deficiencies.
    • Employers must provide a specific deadline as to when the improvements must be made.
    • Employers must define the consequences should the employee fail to improve.
  • Use Probationary Periods. States with probationary period regulations offer a benefit when dismissing an unsuitable employee early in the employment relationship. In some states, the employer will not be charged if an individual was discharged due to job performance within an initial probationary period.
  • Uniformly Enforce Rules. Employers must also implement methods for uniformly enforcing rules, procedures, and policies. Violations of the rules should be properly documented and noted in the employee’s personnel file. Failure to uniformly enforce rules across the company may eventually hurt an employer’s unemployment experience. Unemployment claimants terminated for violating rules, procedures, or policies that were not uniformly enforced may be eligible for benefits.
  • Provide Constructive Counseling. Employees should be given the benefit of a counseling session whenever their performance, conduct, and/or actions fall below standards. Verbal and written warnings should be used to verify the seriousness of the situation. The goals of counseling should be to improve an employee’s chance of continued employment by making the employee more productive.
  • Apply Progressive Discipline. Employers should adopt a standard process of progressive discipline for employees who fail to adhere to workplace rules or reasonable standards of behavior. Supervisors should use progressive discipline to address recurring infractions and workplace problems before actually discharging an employee. Note that such serious problems as fighting, theft, or posing a threat to the safety of others do not need progressive discipline, but are rather a cause for immediate dismissal.
  • Use Suspension, Rather than Firing, Whenever Possible. In most cases, employers should avoid firing employees on the spot and without careful consideration. Temporary suspensions may be used when more time is needed to investigate an apparent infraction or when a volatile situation needs to be defused. When a full investigation has been made and all legal liabilities considered, an employee may be reinstated or discharged.
  • Use Exit Interviews. Exit interviews are an effective way to reduce unemployment benefit charges by identifying employment-related problems that cause employee turnover and hence unemployment liability. They also function as a useful way to determine the actual reasons for resignations and provide opportunities to obtain statements from separating employees. Note that employees who voluntarily quit without good cause are usually ineligible for state unemployment benefits.
  • Voluntary Contributions. Many states permit employers to make voluntary contributions as an optional yearly payment that allows an employer to achieve a lower unemployment compensation tax rate. Upon completion of a payment, the benefits charged to an employer’s account is reduced in benefit ratio states and the reserve/account balance in reserve ration states is increased.

Employee Considerations

Independent Contractors and Unemployment Compensation

Employers may engage independent contractors to provide services to their clients and/or themselves. These self-employed individuals normally provide these same services to other individuals or organizations and are free from the direction and control of the employer to whom they have contracted. True independent contractors cannot file a claim for unemployment benefits since no employer reports the payments made for these services as covered wages under state or federal unemployment laws.

Each state has its own regulations and guidelines to determine whether any specific contract worker qualifies as an independent contractor. Employers must be careful to comply with this distinct interpretation in the states where they use such workers. Employers should contact the appropriate state agency and request a copy of their interpretation of independent contractor status.

Refusal of Suitable Employment

As businesses grow and change, employment needs also change. At times, employers may choose to reassign workers from one job to another or change scheduled work hours and/or location of employment.

If an employer offers an employee a reasonable employment alternative (such as similar hours, pay, and a practical location) and the employee refuses the job offer, the employer should promptly inform the state agency of the specifics of the refusal. Refusal of suitable employment by claimants for unemployment benefits is a serious matter. The penalty in most states for refusing a job is an indefinite disqualification for UC.

Employment Separations

An employmentseparation is when an individual’s employment ends for any reason, such as lack of work, voluntary quitting, termination, or discharge. An employee who voluntarily leaves employment without good cause will be disqualified from receiving unemployment benefits. Accordingly, when an employee left employment for good cause the employee may qualify for benefits. Depending on the issue where a worker is attempting to receive unemployment benefits, the state unemployment agency will assign the moving party with the burden of proving whether the separation was for a good cause. In lack of work and discharge situations, the employer would be the moving party. In voluntary quitting situations, the employee who quits would be the moving party.

Recording Separations

Employers must record the precise reasons for a separation by detailing events leading up to the separation. This form of documentation (a separation notice) provides a useful record for the employer in the following ways:

  • Separating employees should be informed as to exactly why their employment ended. Employers in most circumstances should provide a copy of the separation notice to the separating employee and request acknowledgment of receipt in writing.
  • Supervisors can be made aware that their performance, as related to the separation, is partially reflected in the notice.
  • An accurate separation notice will enhance the employer’s position if a dispute develops regarding a claim for unemployment benefits. A copy of the notice should be placed in the employee’s personnel file.

At a minimum, separation notices must contain all of the following:

  • Employee’s name and Social Security number.
  • Date of the employee’s actual last day on the job.
  • Precise reason for the employee’s separation, including specifics of the final incident causing the separation.

Separation Terminology

Separation notices must be clear and accurate. If the reader cannot visualize the final separation incident, then the facts have not been accurately recorded.

Subjective terminology should be avoided. Former employees should not be characterized as having a bad attitude or as being unable to do something. Former employees should not be labeled as “unreliable,” “careless,” “undependable,” “unsatisfactory,” or “unprofessional.” Additionally, phrases such as “guilty of insubordination,” “poor performance,” and “not suited to the job,” should be avoided. The separation notice should be specific, concrete, and objective.


For employers to successfully protest unwarranted unemployment claims, supervisory personnel must record all relevant facts of each worker’s employment history. Since unemployment claims can be filed against an employer’s tax account several months after the date of separation, written documentation is essential to recall the facts surrounding a separation.

Documentation must be honest and fair and provide a reasonable portrayal of the situation. It must also be objective, representing the facts without assumptions or conjecture.

Good documentation helps control unemployment costs because documentation provides a tangible record demonstrating the employer’s position when a former employee files a claim. To prevail in a disputed unemployment case, employers generally must present evidence that is more convincing than that of the claimant, and accurate documentation demonstrating the truth and validity of an employer’s sworn statements will go a long way toward winning a case. Additionally, such documentation helps employers determine whether an employee has been warned or disciplined for previous employment infractions.

Documentation of any progressive discipline is an essential part of effective documentation. Most ex-employees discharged for work-rule infractions will be denied some or all benefits if it can be proven, through documentation, that the employer has reasonable rules, that employees are aware of these rules, that the employer enforces the rules uniformly, and that the employee was given sufficient warning before being discharged. Employers should also document informal verbal discussions of personnel issues with employees. Supervisors need to record any incidents to assist when recall of the incident may be required in the future.

Any written warning should include the following:

  • The name of the person who issued the warning.
  • The number of warnings issued and the date of issuance.
  • A description of the specific problem or behavior that needs to be corrected.
  • A description of the employer’s expectations regarding the employee’s future behavior.
  • An explanation of how the employer wants the problem resolved.
  • An explanation of future disciplinary action that may be taken if the problem is not resolved.

Employers should have the employee receiving a written warning sign an original to indicate receipt of the warning. Employees must be able to express their disagreement with the warning and their response kept with the warning. Any witnesses should also sign documentation pertaining to what occurred.

Contents of Documentation

Good documentation in UC cases includes at least the following:

  • The names and titles of individuals involved in the incident.
  • Indications of the time, date, and place of the incident.
  • A description of the event and results of the event.
  • Observations about the possible consequences to the employer.
  • Signature of the preparer and any witness.

As with the actual separation notice, documentation supporting separation decisions must use objective language and avoid making conclusions. Supervisors preparing separation documentation language should use objective language, as in the right-hand column provided in the following table, rather than subjective language, as in the left:

Subjective Statements (Avoid)   Objective Statements (Use)
The employee is often late.   The employee was more than 10 minutes late on 2/17, 2/18, 2/25, and 3/1.
The employee was insubordinate.   The employee refused to clean up a broken shampoo bottle from Aisle 6. He shouted, “I’m tired of doing all the dirty work.” When told this was part of his job, he stomped away.
The employee was intoxicated.   On 4/2/10, the employee returned from lunch 15 minutes late. His speech was slurred and he smelled of alcohol. He walked unsteadily and fell twice against a filing cabinet.

Documentation of this type will help employers defend themselves against unwarranted claims for UC.

Additional Regulations

Trade Act

The Trade Act is a federal law that provides Trade Adjustment Assistance (TAA) to American workers who have lost their jobs due to increased imports. TAA also includes a variety of re-employment services and benefits to workers who have lost their jobs or suffered a reduction of hours and wages as a result of increased imports or shifts in production outside the United States. Overall, the TAA program aims to help program participants obtain new jobs, ensure they retain employment, and earn wages comparable to their prior jobs.

To obtain TAA benefits and services, a petition must first be filed with the U.S. Department of Labor requesting certification as workers adversely affected by foreign trade. A petition may be filed by any of the following:

  • A group of three or more workers.
  • A company official.
  • One-stop operators or partners (including state workforce agencies and dislocated worker units).
  • A union or other duly authorized representative of such workers.

The workers on whose behalf a petition is filed must be, or have been, employed at the firm or subdivision identified in the petition. Workers’ employment must be, or have been, related to the production of articles (products) described in the petition. Upon certification, each worker in the group must apply for individual services and benefits through the local One-Stop Center to determine individual eligibility. Such services and benefits include re-employment services, job search allowances, relocation allowances, trade readjustment allowances, health insurance coverage assistance, and training services.

North American Free Trade Agreement

The North American Free Trade Agreement Transitional Adjustment Assistance, or NAFTA/TAA, amended the Trade Act of 1974. This federal legislation provides help to American workers who have lost their jobs due to imports from Canada or Mexico or who became unemployed because of production operations relocated to Canada or Mexico. These benefits include paid training for a new job and financial assistance for a job search in other areas or relocation to an area where jobs are more plentiful. The U.S. Department of Labor and cooperating state agencies administer the NAFTA/TAA program.

Disaster Unemployment Assistance

Disaster Unemployment Assistance (DUA) is a federal program administered by the U.S. Department of Labor and State Employment Security Agencies. Benefits are payable to individuals, U.S. nationals, and qualified aliens who are unemployed due to a disaster declared by the President of the United States and who are not eligible for a regular UI claim.

Benefits are payable only for weeks that fall within the disaster assistance period. The disaster assistance period begins the first day of the week following the date of the disaster and ends 26 weeks after the date the disaster was declared. An individual may only receive the maximum amount of assistance when their unemployment continues to be a result of the major disaster.

Disability Programs

If a person is permanently disabled, the individual should contact the Social Security Administration for information about benefits under its programs. The individual should also apply for state disability insurance because receiving Social Security does not conflict with UI. Additional information may be obtained by contacting the Social Security Administration offices.

If an individual has any employees, that person is required by law to have workers’ compensation insurance. Failure to do so is a crime and may result in penalties and closure of the business.

If an employer has any questions about workers’ compensation insurance or how to obtain coverage, the employer should contact an insurance agent or local state compensation insurance fund.

Contact Information

Employment and Training Agency
https://www.dol.gov/general/topic/unemployment-insurance or http://workforcesecurity.doleta.gov/unemploy/uitaxtopic.asp

Internal Revenue Service

Social Security Administration