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Unemployment Tax Planning: How to Avoid Common Mistakes

For many businesses, paying taxes means filing federal, state, and local income taxes. Many companies overlook unemployment taxes.  Because they are paid quarterly, it’s easy to forget in the middle of hectic day-to-day operations. There’s no media presence reminding organizations to pay these taxes. It’s up to businesses to ensure that these taxes are paid on time.

Unemployment Taxes

Employers pay federal unemployment taxes (FUTA) and state unemployment taxes (SUTA). Only Alaska, New Jersey, and Pennsylvania require employees to pay a state unemployment tax. The taxes are used to fund benefits for unemployed individuals. 

Taxes are placed in a trust fund that states use to pay benefits to qualified individuals. If a state has insufficient funds, it may draw on the federal fund to help bridge the gap. Each state is responsible for administering unemployment benefits.

Unemployment taxes are paid quarterly on dates established by the IRS. Failure to pay taxes on time can result in penalties and fines. Delays in paying these taxes may result in state or federal audits. To ensure that taxes or paid on time and in full, be sure to avoid the following common mistakes.

Poor Hiring Policies

Tax planning begins before a candidate becomes an employee. Unemployment tax rates are partially based on the number of filed claims. To ensure the lowest rates possible, businesses need to minimize the number of unemployment claims. That means hiring the right candidate. When evaluating potential new hires, make sure to:

  • Evaluate how well candidates fit the corporate culture. Include individuals from across the enterprise in the interview process. Diverse interviewers provide different perspectives on how a potential employee fits with the culture.
  • Vet a candidate. Companies must perform their due diligence when it comes to checking an employee’s background. In a rush to hire, critical pieces of information can be missed.
  • Define job requirements. Take the time to review the position requirements. Using an old job description can have unfortunate consequences. No position stays the same as technologies, markets and customers change.
  • Provide training. Making sure a new hire has all the resources necessary to succeed increases the chances of a good hire. It also serves as documentation should the employee claim they were not adequately trained.

No matter how comprehensive the hiring process, companies may have to terminate an employee. How the process is handled can impact unemployment tax rates. Offering outplacement assistance may reduce the time an ex-employee is out of work. Severance packages may also minimize the eligibility period. Knowing how unemployment taxes are assessed can help organizations make informed decisions on how or when to terminate employees.

Employee Misclassification

The most common misclassification is classifying a person as a contractor rather than an employee. According to the IRS, a person is an employee if:

  • A business dictates how, when, where, and how long a person performs job responsibilities.
  • An individual is reimbursed for expenses or is provided supplies or tools without charge.
  • An individual receives defined benefits such as insurance, pension, vacation, or sick time.
  • A business considers the position to be ongoing with duties critical to the success of the company.

However, there are other classifications based on residency status, type of work, and work location. With a growing gig economy, some states such as California are attempting to enact legislation that may change employee classifications. If successful, these state laws could impact employee classifications.

Miscalculation of Taxes

Calculating state unemployment taxes depends on the state in which the employee works. If a company has employees working in different states, the tax must be calculated and paid according to its regulations. Federal taxes are calculated according to the following:

  • Taxes are based on gross pay.
  • Taxes are applied on the first $7,000 per employee per year.
  • Taxes are based on a published rate.

For example, an employee is paid $1,000 per week before any withholding or deductions are made. The tax rate is currently 6%, so the amount of tax due is $60 for a total of $420 per year. 

The IRS, which controls the federal unemployment tax, does allow certain exemptions when calculating gross pay. Some of these exemptions include fringe benefits, expense reimbursements, life and health insurance payments, and employer contributions to retirement plans.

Late or Not Filing

 What happens if you don’t have the funds to pay quarterly taxes? File anyway. If tax forms are not filed, the IRS assesses a failure-to-file penalty. The amount of the penalty is 5% of the unpaid amount. The 5% penalty is charged per month until the balance is paid in full.

To avoid filing penalties, place the weekly amounts in a separate account. If the tax payment amount is maintained in a separate account, it is less likely to be used to pay for ordinary expenses. Even with a different account, businesses, especially in the startup phase, borrow from the account to cover the costs with every intention of paying back the “loan.” Unfortunately, the repayment doesn’t happen.

Instead of not filing, organizations should file and pay whatever they can. Companies can file for extensions or contact the IRS to negotiate an installment payment plan.

Poor Record Keeping

Businesses know to keep records to support their income tax payments. They also need to keep records to support how unemployment payments were calculated. For example, how was gross pay determined for all employees? What criteria were applied to determine employee status? When did raises go into effect? Answers to these questions impact the amount of taxes to be paid.

Proper record-keeping extends beyond tax payments. Human resources must make sure that complete records are maintained on all employees. This means tracking time off, recording training performance, and documenting disciplinary actions. These records can help dispute an employee claim for unemployment.

Not Using Professionals

Unemployment taxes are more complicated than many companies realize. Unlike the federal tax laws, states differ in how they collect and process unemployment taxes and claims. Keeping up with the tax laws can be overwhelming, especially if a business has employees in multiple states. Making sure your organization complies with state and federal regulations means finding knowledgeable professionals to help. If you need a partner to help, schedule a demo to see how our solution can take the worry out of unemployment taxes.

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