An Unemployment Tax Alternative Nonprofits May Want to Consider
By Donna Groh
Nonprofits looking to make every dollar count, particularly those with more than 10 employees, may want to consider taking advantage of a benefit that lets them opt out of the state unemployment system, a move that could save significant funds.
Since 1972, nonprofit employers have had the ability to opt out of their states tax-rated unemployment system and simply reimburse the state if a former employee collects benefits. However, nearly 25% of all nonprofits are unaware of this.
Every state requires that employers pay a certain tax rate into the pooled unemployment fund, which pays out benefits to workers who lost their job through no fault of their own. An employer pays this tax regardless of whether they lay off any employees. But if they do have layoffs, their tax rate can increase in subsequent years.
While providing a much-needed living stipend for job-seekers, the state unemployment insurance system can negatively impact nonprofit budgets:
Nonprofits at the bottom of the tax rate scale subsidize other employers with high claims.
Massachusetts, for example, paid $329,925,736 of benefits in error over the last three years, which comes directly out of employers' pockets. Massachusetts also pays the highest maximum weekly benefit in the nation and has the second highest maximum tax rate at 12.33%.
On average, employers pay about $2.00 in taxes for every $1.00 paid out in actual benefits; the rest goes to administration, repaying federal state unemployment insurance loans, etc.
On the other hand, there are advantages to staying with the state tax-rated system, especially for nonprofit employers that have fewer than 10 employees that expect very dramatic fluctuations in their work force, or that often have seasonal employees.
If claims activity remains constant, the nonprofit can#147;to some extent#147;predict their rate, which helps with budget forecasting.
For those with claims that are higher than taxes paid in, the states tax pooling system will subsidize claims costs. Smaller agencies typically pay less in taxes, and just one claim could cost more than what they have paid in so they are better off remaining in the tax system. However, high claims activity will result in a higher future tax rate.
Leaving the State System to Reimburse on Your Own
One of the biggest advantages to leaving the state tax-rated system is that many nonprofits see an instant savings. And over the long run, periods of low claims typically outweigh short periods of high claims so you end up paying less over time than you would have in taxes.
However, leaving the state system to become a self-reimbursing employer has its own set of drawbacksnamely, the risk to cash flow management. The state does require that all claims are paid as soon as they occur. Because significant fluctuations in employment arent always anticipated, budgets can become pressed if an agency didnt set aside enough cash on-hand to cover all their unemployment expenses.
Many nonprofits elect to join a trust or other third-party reimburser when they leave the state system to add protection and stability to the reimbursing option. By creating a reserve account for claims, trusts aid in protecting an agencys cash flow. Unlike staying in the state system where taxes cannot be refunded, the trust account is an agency-owned asset. Some trusts will even cover claims when your account cant, allowing you to rebuild your account over time and protecting your immediate cash on-hand. Trusts also help to manage and mitigate unwarranted benefits, provide claims court hearing support, and look out for costly state errors.
In most cases, trusts offer additional benefits such as filing the state opt-out paperwork, simplifying budgeting by setting up quarterly reserve deposits, providing stop-loss protection for unusually high claims activity, offering HR training and support, and bond posting in states that require it. A trust can provide significant administrative benefits and can also be an important safety net for nonprofits without the internal resources to properly manage claims.
In the end, of course, it is up to the financial manager of every nonprofit to determine if leaving the state unemployment system is a beneficial option (most trusts can help you evaluate this for free). But for many nonprofits, opting out of the state can save critical mission funding.