Ernst & Young LLP s Guide to unemployment insurance in May 15, 2014

Transcription

1 Ernst & Young LLP s Guide to unemployment insurance in 2014 May 15, 2014

2 Contents Introduction... 1 Federal unemployment insurance... 2 FUTA credit reduction: the added burden of long-term debt... 2 Add-ons to the standard FUTA credit reduction... 4 The 2.7 add-on to the FUTA credit reduction... 4 BCR add-on to the FUTA credit reduction... 4 Recap of the 2013 FUTA credit reduction states... 5 Projected 2014 FUTA credit reduction states... 6 Employer cost of UI trust fund debt financing... 7 President s fiscal year 2015 budget would make FUTA changes... 7 State unemployment insurance State jobless rate...10 Minimum and maximum UI benefits...10 SUI wage base...11 Rate determination method...12 New employers and experience rates...12 Surcharges...13 Statutory elections...13 Mergers, acquisitions and employee transfers Penalty SUI rates...14 UI management Due diligence...16 Lookback review and refund studies...16 Rate review...16 Rate notices and protests...16 UI cost projection...17 UI integrity and claims management UI integrity law overview...18 Employer consequences of late or inadequate responses to claim notices Avoiding the high cost of UI integrity sanctions...20 Teamwork and performance measures are vital...21 Table 1: 2014 state unemployment insurance facts Across the states in Summary... 24

3 Introduction Unemployment insurance (UI) can be a significant employment-related cost and, unlike many other business taxes, can be directly influenced by management performance and organizational behavior. Compared to other business taxes, UI tax rates can also respond more quickly to the local economy due to some state laws that call for automatic employer contribution adjustments based on factors such as the average wage, inflation, the jobless rate and/or the state s UI trust fund balance. Additionally, when state UI trust funds fail to keep pace with UI benefit payouts, businesses in those states may be asked to bear additional costs in the form of special state assessments and/or an increase in the federal unemployment insurance (FUTA) tax rate. Consequently, and particularly for large, multi-state employers, unemployment insurance costs can vary significantly from one year to the next depending on organizational changes (e.g., merger, acquisition), UI benefits charged to the employer s accounts, changes in the UI wage base, adjustments in the base UI tax rates and fluctuations in special assessments (e.g., bond or interest surcharges). How do you rate? Curious if your SUI tax rates and management practices measure up? With UI Fact Finder, you will have the opportunity to participate in our unemployment claims management survey and get free access to state reports providing a snapshot of key UI facts in your work states. UI Fact Finder is online and available anytime you are. Log in here While the federal and state legislative landscape underlying UI tax can be complex, proactively managing this cost is both feasible and prudent. In this publication, we explain the basics of federal and state unemployment insurance and the trends to be aware of in Guide to unemployment insurance in 2014 May 15,

4 Federal unemployment insurance How do you rate? Legislation establishing a nationwide system of unemployment insurance was spawned by the Great Depression and was incorporated under the Social Security Act of Specifically, Titles III and IX of the Social Security Act establish a joint federal-state program of unemployment insurance (UI) whereby states are required to maintain a UI trust fund for the payment of temporary benefits to employees who are separated from their jobs through no fault of their own (as defined by state law). Federal law establishes that employers make contributions to these state UI trust funds based on the state s maximum annual wage limit that, under the current requirements, cannot be less than $7,000 per employee per year. Titles III, IX and XII provide federal support of the state UI system by certifying that states comply with federal guidelines, making federal funds available for extended worker benefits and offering UI trust fund loans (Title XII) to help states finance their trust funds during periods of insolvency. In 1939, the Federal Unemployment Insurance Tax Act (FUTA) was passed, requiring that employers make contributions to offset the federal costs of administering the UI system. Effective July 1, 2011, the FUTA tax rate is 6% of a maximum of $7,000 in covered wages per employee per year. In consideration of state and employer compliance with federal guidelines, employers are eligible for a maximum FUTA credit of 5.4%, thereby resulting in a normal net FUTA rate of 0.6%. FUTA credit reduction: the added burden of long-term debt When a FUTA credit reduction applies, the maximum FUTA credit falls below 5.4%. To lose a portion of the maximum 5.4% FUTA credit means that the net FUTA tax rate rises above the normal 0.6%. For instance, if the maximum 5.4% FUTA credit is reduced by 0.3%, the net FUTA rate increases from 0.6% to 0.9% [6.0% - (5.4% - 0.3%) = 0.9%]. States are given the option of accepting a federal UI loan to augment their UI trust funds. If states do not repay these federal loans within a certain time frame, employers in those states are required to assist in repaying these loan balances through funds obtained from the FUTA credit reduction. Specifically, if a state has an outstanding federal UI loan balance on January 1 of two consecutive years and fails to repay the entire balance by November 10 of the second year, employers in that state are subject to a reduction in the maximum 5.4% FUTA credit. With certain exceptions, the credit reduction increases in 0.3% increments each subsequent year the loan balance remains unpaid. The additional FUTA tax per employee that is the result of this FUTA credit reduction can be substantial, particularly if federal UI loan balances linger over several years. (See Figure 1.) Figure 1: FUTA credit reduction effect before add-on Number of years with outstanding federal UI loan Adjusted net FUTA rate (net FUTA rate of 0.6% + FUTA credit reduction) 2 0.9% $ % $ % $ % $84 Increase over $42 per employee (assuming $7, %) Additional FUTA tax that is owed as a result of the FUTA credit reduction is reflected on Form 940 and is required to be paid by January 31 of the following year. Michigan started borrowing in 2006 and 2007, two years sooner than the recession began affecting most states UI trust fund balances; therefore, a FUTA credit reduction of 0.3% first applied to Michigan employers in 2009, with payment due by January 31, Most of the states obtained their long-term FUTA loans in 2009, resulting in 21 states subject to the FUTA credit reduction in The loan payoff rate has been slow, with 15 states projected to be subject to the FUTA credit reduction again in (See Figure 2.) 2 Guide to unemployment insurance in 2014 May 15, 2014

5 Figure 2: FUTA credit reduction states First year of long term loan Year FUTA credit reduction applies No new long-term loans (estimate) 15 Number of states subject to FUTA credit reduction on Form 940 Obtaining a waiver of the standard FUTA credit reduction Qualifying states can avoid the standard FUTA credit reduction (as South Carolina did for calendar years ), provided the state: Has submitted an application (originating from the governor) to the US Secretary of Labor no later than July 1 of the year for which avoidance is sought Pays the amount that the credit reduction would produce prior to November 10 of the year for which avoidance is sought Repays all UI loans received during the one-year period ending prior to November 10 Obtaining a cap on the standard FUTA credit reduction States can also request a cap on the FUTA credit reduction imposed for the year, beginning with the second taxable year a credit reduction is applicable. The credit reduction would be capped at the higher of 0.6% or the credit reduction that applied for the previous calendar year. To qualify for a cap on credit reductions, a state must: Submit an application from the governor to the US Secretary of Labor no later than July 1 of the year for which a cap is sought Take no action (legislative, judicial or administrative) during the 12-month period ending September 30 of the year for which a cap is requested that would reduce taxes or solvency for that same time period Have an average tax rate on total wages for the taxable year that equals or exceeds the average benefit cost ratio for the five years ending with the preceding calendar year Have a loan balance on September 30 of the taxable year that is less than or equal to the loan balance on September 30 of the third preceding year. ( Important dates for Title XII advances and repayments, U.S. Department of Labor website.) Georgia requested that its FUTA credit reduction be capped for 2013 at the 2012 level; however, the request was denied because the state failed to meet the qualification requirements. Increases solvency for the taxable year through legislative action by an amount equal to or greater than the amount of the FUTA credit reduction Does not borrow again before the next January 31. ( Important dates for Title XII advances and repayments, U.S. Department of Labor website.) A state that is granted a waiver of the standard FUTA credit reduction sees its FUTA tax credit fully restored, resulting in the normal net FUTA rate of 0.6%. Guide to unemployment insurance in 2014 May 15,

6 Federal unemployment insurance How do you rate? Add-ons to the standard FUTA credit reduction Federal law discourages states from carrying their loan balances for more than two years by imposing an additional add-on to the standard FUTA credit reduction. One of two such add-ons can apply, the 2.7 addon (see next section) and the Benefit Cost Rate (BCR). (See Figure 3.) The 2.7 add-on to the FUTA credit reduction Federal law encourages states that carry a loan balance to ensure that employers are making the appropriate level of contributions to the UI trust fund to better ensure a path to future solvency. For this reason, a special penalty, known as the 2.7 add-on, triggers in the third year a state carries a federal loan if the state s average UI tax rate is lower than allowed as compared to a formula provided for under FUTA law. This special penalty applied to Virgin Islands employers in 2012 and 2013, but, according to a U.S. Department of Labor representative, it is not expected to apply for calendar year There is a possibility, though unlikely, that Delaware employers could face the 2.7 add-on for calendar year 2014, since the state is in its fourth year of borrowing. Figure 3: The accumulating cost of the FUTA credit reduction Full FUTA rate Maximum Net FUTA rate credit reduction 6.0% 5.4% 0.6% Credit reduction BCR add-on to the FUTA credit reduction Federal law discourages states from carrying their loan balances over several years by further reducing the FUTA credit in the fifth year of the loan. This add-on to the FUTA credit reduction is referred to as the Benefit Cost Rate (BCR). The BCR will trigger this year in several states which began borrowing in 2008 and The BCR add-on is computed for 2014 using: the average benefit cost for calendar years 2009 through 2013; the calendar year 2013 state taxable wages; and the calendar year 2013 average annual tax rate on total wages. Waiver of the BCR add-on The BCR penalty may be waived for 2014 if the state s governor submits an application to the US Secretary of Labor no later July 1, 2014, and the state takes no action (legislative, judicial or administrative) during the 12-month period ending September 30, 2014, that would reduce UI trust fund solvency during that same time period. 2.7 add-on, once triggered, cannot be waived. Should the BCR add-on be waived, as is normally the case if the conditions are met, the 2.7 add-on (that was imposed on the Virgin Islands for ) can kick in if the state s average UI tax rate is inadequate and cannot be avoided or waived if triggered on. According to a U.S. Department of Labor representative, this is not expected to apply for calendar year 2014 for any of the credit reduction states, even the Virgin Islands. The 2.7 add-on when triggered cannot be waived. (See Figure 3.) If neither the BCR or the 2.7 add-on applies, the standard FUTA credit reduction as shown in Figure 1 would apply in 2014 (e.g., 1.2% for the states that began borrowing in 2009, for a total net FUTA rate of 1.8%). ( Important dates for Title XII advances and repayments, U.S. Department of Labor website.) Year 2 of federal loan + 0.3% each year Year 3 of federal loan 2.7 add-on + or Year 5 of federal loan Benefit Cost Ratio (BCR) The BCR triggered in 2013 in two states, Indiana and South Carolina, which began borrowing in Both states requested, and received, waiver of the BCR add-on for Can t be waived if triggered 4 Guide to unemployment insurance in 2014 May 15, 2014

7 Figure 4: California FUTA credit reduction example Interest on loan due by September 30 was temporarily waived under federal law. Risk of additional FUTA credit reduction is triggered under the 2.7 add-on, but did not apply. FUTA credit reduction of 0.6% applies, increasing net FUTA rate to 1.2% (0.6% + 0.6%). Interest on loan due by September 30, paid by loan from state disability trust fund. Additional BCR of estimated 1.5% could apply. Or, additional 2.7 add-on to FUTA credit reduction could apply (but unlikely) and, if assigned, cannot be waived. FUTA credit reduction of 1.2% applies, increasing net FUTA rate to 1.8% (0.6% + 1.2%). Projected net FUTA rate is 3.3% (1.5% BCR + 1.8%). Interest on loan due by September California initiates its federal unemployment insurance loan. FUTA credit reduction of 0.3% applies, increasing net FUTA rate to 0.9% (0.6% + 0.3%) effective July 1 (1.1% through June 30). Interest on loan due by September 30, paid by loan from state disability trust fund. Risk of additional FUTA credit reduction under the 2.7 add-on, but did not apply. FUTA credit reduction of 0.9% applies, increasing net FUTA rate to 1.5% (0.6% + 0.9%). Interest on loan due by September 30, paid by loan from state general fund. Recap of the 2013 FUTA credit reduction states Employers in 13 states and the Virgin Islands were subject to the FUTA credit reduction for calendar year 2013 and consequently they paid a higher FUTA tax rate than employers in other states because these states failed to repay their outstanding federal UI loans by November 10, The increased FUTA taxes were due from employers with their fourth quarter 2013 federal unemployment tax deposit on January 31, ( States with 2013 Federal Unemployment Tax Act (FUTA) credit reductions, U.S. Department of Labor, November 12, 2013.) Indiana. Employers in Indiana saw a 1.2% FUTA credit reduction for 2013 because it was the fourth penalty year. Indiana employers potentially faced an even higher FUTA cost because the state had carried its federal loans for five years. However, the state requested, and received, a waiver of the BCR add-on for South Carolina. For the third year in a row, South Carolina requested, and received, a waiver of the FUTA credit reduction for As with Indiana, South Carolina employers potentially faced the addition of the BCR factor because the state had carried its federal loans for five years. However, the state requested, and received, a waiver of the BCR add-on. As a result, although the state still had an outstanding loan balance, South Carolina employers paid at the normal net FUTA rate of 0.6% for Virgin Islands. Virgin Islands employers again in 2013 faced the special 2.7 add-on that applied in 2012 because of having an average state UI rate that was lower than allowed under federal law. However, the penalty was lower for 2013, and the net FUTA rate that Virgin Islands employers paid at was 0.3% less than the 2012 rate. Georgia. Georgia requested that its FUTA credit reduction be capped for 2013 at the 2012 level; however, the state did not qualify for the cap. As a result, Georgia businesses saw a net FUTA rate of 1.5%, the same as businesses in other states that began borrowing in Guide to unemployment insurance in 2014 May 15,

8 Federal unemployment insurance How do you rate? Projected 2014 FUTA credit reduction states Figure 5 below shows the states that are thus far potentially at risk of a FUTA credit reduction in 2014, assuming that nothing changes between now and November 10, Several states plan to avoid a 2014 FUTA credit reduction by repaying their federal loan balances before November 10, States may also request a waiver of the standard FUTA credit reduction or Congress could adopt the President s proposal to waive the FUTA credit reduction entirely for (See page 7 for the President s fiscal year 2015 budget proposal.) Note that the projected 2014 net FUTA rates reflected in Figure 5 include the BCR add-on, as projected by the U.S. Department of Labor. The Department projects that should the BCR be waived, none of the states would qualify for the 2.7 add-on, even the Virgin Islands. The Department plans to release an updated estimate of the add-ons that could apply later in the year. Figure 5: FUTA credit reduction states tax year 2013 compared to tax year 2014 projections State First year of loan 2013 FUTA credit reduction Net 2013 FUTA rate Projected 2014 FUTA credit reduction Projected 2014 BCR add-on Arkansas 1, % 1.5% 1.2% 0.5% 2.3% California % 1.5% 1.2% 1.5% 3.3% Connecticut % 1.5% 1.2% 0.5% 2.3% Delaware 2, % 1.2% 0.9% 0.0% 1.5% Georgia 1, % 1.5% 1.2% 0.6% 2.4% Indiana % See comments Projected potential 2014 net FUTA rate Comments 1.8% 1.5% 1.2% 3.3% A waiver of the BCR add-on applied in Kentucky % 1.5% 1.2% 1.0% 2.8% Missouri 1, % 1.5% 1.2% 0.4% 2.2% New York % 1.5% 1.2% 0.7% 2.5% North Carolina % 1.5% 1.2% 0.5% 2.3% Ohio % 1.5% 1.2% 1.4% 3.2% Rhode Island 1, % 1.5% 1.2% 1.0% 2.8% South Carolina See comments 0.6%** See comments Virgin Islands % See comments 1.8% See comments 1.5% See comments 0.5% 2.6% See comments Wisconsin 1, % 1.5% 1.2% 0.1% 1.9% A waiver of the standard FUTA credit reduction applied in and a waiver of the BCR addon in Waivers could also apply in 2014, resulting in the normal net FUTA rate 0.6%. 1.2% 1.6% 3.4% In , the 2.7 add-on applied, but it will not apply in 2014, according to the U.S. Department of Labor. Legend 1 Estimated BCR courtesy of U.S. Department of Labor. The 2.7 add-on could apply if BCR add-on is waived; however, the Department does not anticipate this to be the case for The state s employers are at risk of the 2.7 add-on. 3 The state plans to repay the loan before November 10, 2014, and avoid the 2014 FUTA credit reduction. 6 Guide to unemployment insurance in 2014 May 15, 2014

9 Employer cost of UI trust fund debt financing When states finance UI claim payouts with a federal loan, interest becomes due on the loan each year on September 30. States are not allowed to take money from their UI trust funds to pay these interest charges. Some states have agreed to fund interest assessments from their general revenues or other state funds, but this is not always the case. Consequently, employers may be required to pay a special interest assessment in addition to their normal SUI taxes. Some states have issued bonds or have relied on other interestbearing options to repay their federal UI loans. Accordingly, bond or similar interest assessments may apply to employers, whether or not the state has repaid its federal loan. See Figure 6 for a summary of the states where employers face these special interest assessments in Figure 6: States with employer UI loan/bond interest assessments in 2014 President s fiscal year 2015 budget would make FUTA changes Similar to last year, the Administration is proposing to address the continued insolvency of state unemployment insurance (UI) trust funds by raising the federal unemployment insurance (FUTA) wage base to $15,000 starting in 2017 and indexing it each year thereafter based on wage growth. The purpose of this proposal is to force 32 states to increase UI tax by raising their UI wage base to the $15,000 federal minimum. (See Figure 7.) In 1976, a temporary 0.2% surtax was added to the FUTA rate. The surtax was extended numerous times until it was allowed to lapse effective July 1, The Administration again proposes to reinstate the 0.2% surtax and to make it permanent effective with wages paid on or after January 1, So that employers aren t subject to an increase in their FUTA tax because of the increase in the FUTA wage base, the budget also calls for lowering the net FUTA tax rate from 0.8% (0.6% plus the reinstated temporary surtax of 0.2%) to 0.37%, effective in State Arkansas Colorado Connecticut Illinois (included in SUI rates) Indiana (multiplier included in base SUI rate) Kansas (paid by negative-balance employers) Kentucky (surcharge applies in 2014) Michigan (included in SUI rates) Missouri Nevada New York Pennsylvania Rhode Island (sunsets in 2015 if loan paid in full) South Carolina Virgin Islands Wisconsin (not in effect for ) Type of debt assessment Title XII Bonds Title XII Bonds Title XII Loan from state fund Title XII Bonds Title XII Bonds Title XII Bonds Title XII Title XII Title XII Title XII The budget again addresses concern about the adverse impact of higher UI tax on job growth by proposing a two-year (2014 and 2015) waiver of interest charges applicable to states that continue to carry a federal UI loan balance. For 2014 and 2015, the FUTA credit reduction paid by employers in states carrying a UI loan balance would also be waived. Figure 7: States affected by raise in wage base to $15, SUI wage base below $15,000 Alabama Kentucky Ohio Arizona Louisiana Pennsylvania Arkansas Maine Puerto Rico California Maryland South Carolina Colorado Massachusetts South Dakota* District of Columbia Michigan Tennessee Florida Mississippi Texas Georgia Missouri Virginia Illinois Nebraska West Virginia Indiana New Hampshire Wisconsin Kansas New York *Set to increase to $15,000 in 2015 Guide to unemployment insurance in 2014 May 15,

10 Federal unemployment insurance How do you rate? Raising the federal wage base could have a significant monetary impact on large multi-state employers. Example: Assume that in 2014 an employer has a US workforce of 10,000 employees distributed evenly in the states of California, New Jersey, New York, Ohio and Texas and that its average SUI rate in these states is 3.0%. As shown in Figure 8, the employer s SUI taxes would increase by close to $1.5 million as a result of raising the states wage base to a minimum of $15,000. Shown in Figure 8 is an example of how an increase in the wage base would increase FUTA expenses using the 2014 wage base in the analysis. Figure 8: Multi-state employer impact of increase in federal wage base to $15,000 State Taxable wage base Employees Taxable payroll Average UI rate Total SUI tax cost in 2014 Total SUI tax if wage base at $15,000 California $7,000 2,000 $14,000, % $420,000 $900,000 New Jersey $31,500 2,000 $63,000, % $1,890,000 $1,890,000 New York $10,300 2,000 $20,600, % $618,000 $900,000 Ohio $9,000 2,000 $18,000, % $540,000 $900,000 Texas $9,000 2,000 $18,000, % $540,000 $900,000 Total $4,008,000 $5,490,000 8 Guide to unemployment insurance in 2014 May 15, 2014

11

12 State unemployment insurance How do you rate? Federal law allows the states, within certain limits, to determine how employer state unemployment insurance (SUI) rates will be determined. SUI contribution rules vary depending on if the employer is reimbursing or experience-rated. Experience-rated employers. All private businesses are assigned an SUI rate based on their experience. SUI contributions are computed by multiplying each employee s wages up to the state s wage limit by the SUI rate assigned to the employer. Reimbursing employers. Nonprofit and governmental employers may be experience-rated or they may elect to be reimbursing. Reimbursing employers generally repay UI benefit charges dollar for dollar. In all cases, the UI benefits paid to an employer s separated workers directly affect the employer s SUI costs. For experience-rated employers, the following state-driven factors can directly or indirectly determine the SUI tax they will pay: State jobless rate Minimum and maximum UI benefits SUI wage base Rate determination method New employer and experience rates Special surcharges and assessments Statutory elections that can lower the SUI rate Rules governing transfer of wages and experience (mergers, acquisitions and employee transfers) Penalty SUI rates State jobless rate The national unemployment ( jobless ) rate for March 2014 was 6.7%, comparing favorably to the November 2013 rate of 7.0% and a significant improvement from the April 2010 rate of 9.9%, when the number of states requesting federal UI (Title XII) loans had reached its peak. One indicator of risk for higher future UI costs is the extent to which a state s jobless rate negatively varies from the national average. For this reason, the U.S. Department of Labor (DOL) ranks the states in order of this statistic. In March 2014, 18 states had jobless rates greater than the 6.7% national average for the same period. North Dakota carried the lowest unemployment rate (2.6%) and Puerto Rico the highest (14.7%) during this period. Minimum and maximum UI benefits States determine the maximum duration workers can receive benefits; however, most set the limit for regular benefits at 26 weeks. Massachusetts (at 30 weeks) and Montana (at 28 weeks) are the only states with a maximum benefit period exceeding 26 weeks. The maximum weekly benefit varies considerably by state and can include additional amounts for dependents. In 2014, Puerto Rico had the lowest maximum weekly benefit ($133) and Massachusetts the highest ($1,019). Generally, the more generous a state s UI benefit package, the higher the UI cost for its employers and the larger the drain on UI trust fund balances. Due to the latter, there has been a trend in recent years to cut back on benefits, particularly by reducing the maximum number of weeks a qualifying beneficiary can receive benefits. In 2011, Michigan was the first to cut workers benefits by reducing the number of weeks (to 20 from the standard 26) that claimants may collect SUI benefits, a provision mirrored by Missouri and South Carolina. Arkansas and Illinois were milder in their benefit cuts in 2011, reducing the number of weeks of SUI benefits from 26 to 25. Florida, Georgia and North Carolina adopted a unique approach to cutting benefits by implementing a sliding-scale reduction in benefit weeks based on the average state jobless rate. Florida s maximum benefit weeks range from 12 to 23, effective January 1, 2012; Georgia s range from 20 to 26, effective July 1, 2012; and North Carolina s range from 12 to 20 weeks, effective July 1, Guide to unemployment insurance in 2014 May 15, 2014

13 Standard and alternate base period States also differ in their method for determining benefit eligibility. All states require a worker to have earned a certain amount of wages, worked for a certain period of time or both to be monetarily eligible to receive unemployment compensation benefits. Generally, an individual s wages are drawn from a one-year period (four calendar quarters) to calculate eligibility. The standard base period (SBP) used by all the states (except Massachusetts, which uses the last four completed calendar quarters) to determine claimant eligibility for unemployment benefits is the first four of the last five completed calendar quarters. For workers failing to qualify under the SBP, 38 states use an alternative base period (ABP). Under the ABP, generally the last four completed calendar quarters are used to determine claimant eligibility for benefits. For example, if the worker fails to qualify using wages and employment in the first four of the last five completed calendar quarters, then the state will use wages and employment in the last four completed calendar quarters. (See Figure 9.) Finally, several states use an extended base period (EBP) so that individuals who have no wages in the current base period may qualify for benefits using older wages and employment under certain conditions. These conditions typically involve illness or injury. For example, for a worker who was injured on the job and who has collected workers compensation benefits, the state may use wages and employment preceding the date of the worker s injury to establish eligibility. Use of the ABP or EBP expands the number of eligible claimants, making them a variable to consider when projecting future SUI costs. Figure 9: SBP and ABP illustrated SUI wage base State UI trust funds are largely financed by employer contributions (except in Alaska, New Jersey and Pennsylvania, where employees also make contributions). States are required to maintain an SUI wage base of no less than the limit set under FUTA. The 2014 FUTA wage base of $7,000 has remained unchanged since 1983, despite increases in the federal minimum wage and annual cost-of-living adjustments over the last 31 years. Some states are conservative in their approach to maintaining adequate UI trust fund reserves. Consequently, the UI wage base is flexible, meaning it is indexed to the average wage or varies based on the trust fund balance. According to the DOL, 22 states and the Virgin Islands have a flexible wage base in Conversely, in 2014, the wage base is fixed in 29 states and Puerto Rico. (U.S. Department of Labor, Comparison of State Unemployment Laws, May 2014.) The recent strain on UI trust fund reserves sparked numerous state wage base changes. As a result, only three jurisdictions continue to have a wage base of $7,000 (Arizona, California and Puerto Rico), compared to seven in 2010 (although in Louisiana and Tennessee the taxable wage base can decrease to $7,000 when the trust fund reaches a certain level, and in Florida the taxable wage base is scheduled to revert to $7,000 in 2015). The U.S. Government Accountability Office (GAO) has expressed the view that while the last recession has drained UI reserves, many states had been failing to keep pace with inflation since the recession that ended in 1975 and had less of a buffer to withstand a high-cost benefit period. (GAO, Long-standing State Financing Policies Have Increased Risk of Insolvency, April 2010.) 4th quarter st quarter 2014 SBP 2nd quarter 2014 ABP 3rd quarter th quarter 2014 How well SUI trust funds will withstand another recession is a concern that will drive UI costs in upcoming years. Guide to unemployment insurance in 2014 May 15,

14 State unemployment insurance How do you rate? Rate determination method In order to determine the UI experience of an employer, each business entity is assigned an account into which taxable payroll is reported, contributions are made and from which UI benefits are paid. The specific experience rate assigned to a business depends on some variable of the benefits charged against an employer s account, the contributions (UI tax) paid to that account and the employer s taxable payroll. The primary methods used in SUI rate determinations are reserve ratio and benefit ratio. Reserve ratio Under the reserve ratio method, the employer s account is increased by the contributions the employer has paid and reduced by the UI benefits paid to its unemployed workers during the year. The reserve ratio is the balance (reserve) in the employer s account (UI contributions less benefit charges) divided by the employer s average taxable payroll for a specific period of years (usually three), expressed as a percentage. This resulting reserve ratio is matched to the state s UI rate table to determine the assigned rate. The higher the ratio, the lower the tax rate. Benefit ratio method The benefit ratio method considers the relationship between the unemployment benefits charged to the employer s account during a stated period and the employer s total taxable payroll for that period. The employer s UI contributions are not factored into the equation. Once an employer s benefit ratio is calculated as benefit charges divided by taxable payroll, the employer s UI contribution rate for the upcoming year is usually equal to the benefit ratio, plus other statedetermined factors based on economic conditions. The lower the benefit ratio, the lower the tax rate. Other methods Delaware and Oklahoma use the benefit wage ratio method, and Alaska uses a method called payroll variation. Michigan and Pennsylvania use a combination of the reserve and benefit ratio methods. Note that states can change their experience rating systems, and if they do so, this can change the SUI rates of employers. For instance, South Carolina changed from reserve ratio to benefit ratio (effective with 2011 tax rates), and New Mexico will make the same change (effective with 2015 tax rates). New employers and experience rates New employer rates When a business first begins to employ workers, it is generally assigned a new employer rate until it has met the required period for merit (experience) rating. A number of states assign a new employer based on industry. Most commonly, a higher new employer rate applies to the construction industry. In Kentucky, for instance, the new employer rate for 2014 is 2.7% and 10.0% for the construction industry. Interstate transfers a re-emerging trend in 2014 A re-emerging trend in 2014 is to give employers transferring into a state the option of transferring their SUI experience from a prior state, referred to as an interstate transfer, a provision adopted by Kansas (HB 2576, effective July 1, 2014) and Tennessee (HB 1386, effective July 1, 2014). A few others states (e.g., Michigan and New York) have allowed for interstate transfers for many years. The intent of the legislation is to encourage businesses, under limited circumstances, to transfer their operations into the state by removing the potential penalty of a higher new employer rate. Experience rating States use schedules to convert an employer s individual experience rating into a contribution/tax rate. In some of the benefit ratio states, the benefit ratio itself is the employer s SUI rate. The minimum and maximum rates generally depend on the state s UI trust fund balance; however, under federal law, the maximum rate must be at least 5.4%. Array system of rate assignment. A number of states use a more complex array system that annually ranks employers against each other rather than using a schedule of predetermined experience levels. In 2014, an array system is used by Alaska, Idaho, Iowa, Kansas, Maine, Montana, Nebraska, North Dakota, Oregon, South Carolina and Vermont. Automatic rate schedule adjustments and rate freezing. In some states, the minimum and maximum rates are scheduled to automatically move up or down, depending on formulas that measure the adequacy of the UI trust fund. Theoretically, automatic rate schedule adjustments keep UI trust funds in balance; however, legislators sometimes circumvent this process by freezing the rate schedule when a sluggish economy triggers an increase in UI rates. For instance, Massachusetts enacted legislation in 2014 that continues the freeze at Schedule E, with rates ranging from 1.26% to 12.27%, a move that spared Massachusetts employers from a 33% rate increase. While rate freezes have a beneficial short-term effect on employers UI costs, they can delay trust fund recovery and postpone or extend cost increases into the future. 12 Guide to unemployment insurance in 2014 May 15, 2014

15 Surcharges In addition to interest or bond assessments discussed in more detail on page 17, many states also impose surcharges on new and experiencerated employers for worker retention, job development and other costs that cannot be financed from UI base contributions. For 2014, 27 states impose a surcharge for other than debt financing costs. It is important for employers to keep in mind that for FUTA credit purposes, it is only contributions made pursuant to the state UI base rate that are taken into account. Statutory elections Some states commonly make two statutory elections available to employers to potentially lower future SUI rates: voluntary contributions and joint accounts. Common to both statutory election options is the need to carefully determine whether they will result in cost reduction, because once made, they are irreversible for the statutory period. Voluntary contributions In reserve ratio states, voluntary contributions increase the reserve balance in an employer s SUI account and, if the increase is sufficient, can lower the SUI rate. For the few benefit ratio states that allow voluntary contributions, these contributions can decrease the amount of benefit charges used in the rate computation and lower the SUI rate. Joint accounts The common rate/joint account is an option available in some states (e.g., New York) for employers with two or more commonly owned companies in the same state (Arkansas, Missouri, New York and West Virginia do not require common ownership of the companies). This option allows the employer to request that the state combine the SUI tax experience of two or more companies in the state for SUI rating purposes. When determining if there is a cost-benefit advantage to forming a joint account, it is important to consider the state s lock-in period the period of time the joint account must remain in place before the employer can dissolve it. Depending on the state, lock-in periods vary from one year to an indefinite period. Dissolution of most common rate/joint accounts can be accomplished only by written request at the expiration of the lock-in period. Hawaii automatically terminates common rate/joint accounts after one year. Knowledge of the requirements for and limitations of making statutory elections is essential to avoid costly errors. For more information on statutory elections, see our special report. Twenty-six states (as of January 1, 2014) have provisions allowing employers to make annual voluntary contributions (for 2014, the voluntary contribution option is not available in California). In all but Minnesota, Texas and Washington, the voluntary contribution can alter the employer s reserve ratio and reduce the assigned UI rate by at least one incremental step. These states use a reserve ratio formula (or a variation or combination thereof) to calculate SUI rates. The employer s reserve balance (total SUI paid less total UI benefits charged) is divided by the employer s average taxable payroll for a one- to five-year period (depending on state law). The resulting figure is the reserve ratio, which is keyed to an SUI rate table to determine the assigned tax rate. Voluntary contributions can increase the reserve balance to the next highest reserve ratio bracket (or further) listed in the SUI rate table and may generally reduce the employer s assigned SUI rate. Deciding whether a voluntary contribution should be made requires two calculations: 1. Determination of the amount of the voluntary contribution necessary to effect an SUI rate reduction 2. Assessment of the profitability of making the voluntary contribution Guide to unemployment insurance in 2014 May 15,

16 State unemployment insurance How do you rate? Mergers, acquisitions and employee transfers Positive and negative cost fluctuations can occur as the result of a change in the business, such as acquisitions, mergers, reorganizations or the transfer of employees to new state job locations. Because all of these transactions potentially shift the experience of an employing unit, specific rules govern when businesses may transfer employees between UI accounts and when they can transfer wages for purposes of determining if the UI wage base has been reached. In fact, as a result of federal legislation enacted in 2004 (P.L ), states are watchful of the suspicious and unlawful movement of employees between UI accounts for the sole purpose of dumping negative experience and will impose specific monetary consequences. For these reasons, whenever all or part of another business is acquired, the state rules governing the transfer of the wages and experience from the predecessor to the successor should be complied with. Total and partial transfers Most states mandate the transfer of experience and wages when all of a business is acquired. In the case of a partial transfer, however, some states make the transfer of experience optional unless there is common ownership of the entities. When a partial transfer is voluntary, businesses should carefully consider if there are advantages in exercising the option. For example, is there an immediate UI tax reduction available due to the transfer of wages (for partial transfers occurring after the beginning of the year), and is there a projected positive impact on the future UI experience rate? Conversely, if transferring the experience would adversely affect future SUI rates, the employer would likely not exercise the option. Example 2: Further assume that WidgeCo s SUI rate is the highest rate for Kansas employers at 7.4%. You have had no claims against your Kansas UI account, and you pay at the lowest rate of 0.09%. The result of transferring WidgeCo s experience is an upward adjustment in your Kansas UI rate, with the rate falling between 0.09% and WidgeCo s higher rate of 7.4%. Transferring employees across state lines When an employer transfers employees from one state to another within the same calendar year and under the same federal account number, most states (with the exception of Louisiana, Minnesota and Montana) allow a credit for wages paid in the previous state up to the new state s wage limit. Example 3: Assume an employee earned $12,000 in Kansas through June Wages up to the Kansas wage base of $8,000 are credited against the wage base in the state of transfer. Therefore, if the employee moved in July 2014 to Arizona, which has a wage base of $7,000, no SUI tax would be owed in Arizona for this employee for the remainder of For more information about transferring SUI wages when employees change their work state, read our blog. Penalty SUI rates In 2014, several states (i.e., Alaska, Indiana, Montana, Ohio, Pennsylvania, Virginia and Washington) increase the employer s SUI rate if the employer fails to comply with various UI requirements, such as filing UI returns and making timely SUI payments. In some cases, the penalty rate is the highest SUI rate assigned to businesses. Example 1: Assume in October 2014 you purchased a segmented portion of WidgeCo s assets, including four of its Kansas employees. The Kansas wage base is $8,000, which all employees wages exceeded prior to October, and your UI rate is 1.44%. You pay $10,000 to each of these employees through December By transferring the wages paid by WidgeCo through October 2014, the SUI tax savings are $461 for 2014 ($8,000 4 employees 1.44% = $461). 14 Guide to unemployment insurance in 2014 May 15, 2014

17

18 UI management How do you rate? Considering the significance of unemployment insurance costs, it is prudent business practice to establish and maintain an unemployment insurance management system that includes protocols for due diligence, lookback review, rate review, rate protest, cost projection and claims management. Due diligence When deciding whether to purchase a business, and in deciding subsequent to a purchase how the organization(s) will be structured, a company should consider the SUI cost element. Necessary to this analysis is the SUI rate history of the entities, as well as skill and experience in applying the state rules that govern. For instance, state rules governing the transfer of experience vary based on factors such as common ownership and bankruptcy. (For more information concerning mergers and acquisition, see page 14.) Lookback review and refund studies A lookback review/refund study investigates UI data for prior years within the statute of limitations to make sure that material issues and transactions weren t overlooked. Periodic lookback reviews are often beneficial to businesses that have been involved in mergers, acquisitions or other transactions that involve the movement of employees between UI accounts or the movement of employees within the same UI account to different work locations. Businesses frequently request a lookback review subsequent to purchasing another business, particularly if UI taxes were not reviewed in detail in the due diligence process. While the desired outcome of a lookback review is refund opportunities, areas of material noncompliance may also be detected, giving the business an opportunity to voluntarily disclose its findings and potentially mitigate punitive consequences. Documents generally needed in a lookback review include: The past three years federal and state employment tax returns and other related documents (i.e., SUI rate notices and benefit charge statements) Forms W-2 or other documents showing employee work state history Rate review As shown in Figure 10, a number of circumstances can lead to an error in the SUI rate and can result in significant SUI overpayments, depending on the state(s) and number of employees involved. A thorough review of an SUI rate involves verifying every component used in the state s rate determination, including benefits charged against the account. Figure 10: Errors that can result in an incorrect UI rate assignment State error Incorrect assignment of higher penalty rate All employer contributions not posted Benefits charged incorrectly to account Taxable payroll and reserve balances not timely or correctly transferred Incorrect or untimely posting of statutory elections Rate notices and protests Employer error Failure to transfer previous state wages when employee moves to another state Failure of successor to take into account wages paid by predecessor Failure to notify state of a total or partial acquisition Not taking advantage of statutory elections Not timely dissolving joint accounts that are no longer advantageous Each year, states notify employers of the SUI rate assigned to them. Rate notices may be mailed to employers, or they may be available via the state workforce agency s online SUI system. Each state has a deadline in which employers can protest the SUI rate assigned to them, and for this reason it is important that rate reviews are scheduled to take into account the date rate notices are issued and the protest deadline. It is also important that all parties receive timely notification of SUI rate information, including third parties that process SUI returns and SUI tax payments and those who assist in in the UI management process. Occasionally, retroactive legislation may be enacted that changes SUI rates already assigned. For this reason it is also essential to monitor state developments regularly and throughout the year. A description of the company s mergers, acquisitions and restructurings for the prior three years A copy of the company s organizational chart describing the parent subsidiary legal structure 16 Guide to unemployment insurance in 2014 May 15, 2014

19 UI cost projection Many states do not issue SUI rate notices until after the calendar or fiscal year has commenced. Therefore, the actual SUI rate is not known until at or near the filing of the first-quarter state unemployment tax return (later for states where the rating period is the fiscal year, not the calendar year). As a result, there is a period during the year that businesses must estimate their SUI expense. The accuracy of the financial statement is impaired when the state SUI rate projection is too high or too low. A number of factors can affect the future UI rate and corresponding tax expense of a business. For instance, a planned increase or decrease in headcount, or an acquisition or other reorganization involving a transfer of employees from one state to another or one account to another, can raise or lower the UI rate and affect financial forecasting. For all of these reasons, it is important that pertinent information be accumulated and analyzed for SUI rate projection and accrual purposes on an ongoing basis. Information required for this process includes beginning account balances, quarterly payments and adjustments, UI benefit charges and credits, current taxable payroll, and estimated future staffing levels. Taking all of this information into account, a skilled internal resource or third-party provider must apply the state s specific tax rate calculation methodology to arrive at a reasonably accurate projection of the future unemployment tax rate. Each state approaches the UI rate calculation differently; therefore, this can be an extremely complicated yet vital analysis for the multi-state employer. Complicating UI cost projections currently are variables that now apply in the FUTA tax adjustments arising from the FUTA credit reduction. This too must be taken into account in cost forecasting. (See page 2 for more on the FUTA credit reduction.) An accurate UI tax rate projection holds value beyond the budgeting and forecasting process. It establishes a solid benchmark from which to evaluate the accuracy of the SUI rate once a state has assigned it. Guide to unemployment insurance in 2014 May 15,