Unemployment Taxes for 501(c)(3)s: Alternatives
Monday, January 14, 2013
Posted by: Joy Ingram
by Ellen Dupuy, 501(c) Agencies Trust
At least 25% of the NWRPCA membership has elected to fund their unemployment through the “reimbursement” method of coverage, rather than pay state unemployment taxes. This option may save those members hundreds or thousands of dollars each year.
By law, in every state, 501(c)(3) organizations can pay for unemployment claims in one of two ways: by paying state unemployment insurance tax (SUI) or as a reimbursing employer paying your state only for claims paid to former employees.
With the escalating cost of SUI taxes and increases in the taxable payroll, more and more nonprofit employers are examining the pros and cons of each option. Here is some information that may be helpful.
Advantages of Paying Unemployment Taxes
As a taxpayer, the state unemployment department will cover all the cost of unemployment claims/benefits to your former employees, (but you can probably expect tax increases in subsequent years).
Disadvantage of Paying Unemployment Taxes
A tax-paying employer receives a tax rate notice from the state annually with your new tax rate, as well as increases in the taxable payroll. Even if your claims were low, you may still get an increased tax rate because most states are rebuilding their SUI “pools” because of high claims the last three years.
Also, most states in our region have very high taxable wages. Washington state has the highest taxable payroll of $39,800 per employee; AK may increase to $36,900 (currently it is $35,800), OR is $34,100, and Idaho is $34,100. This costs the nonprofit employer a lot of money each year.
Advantages of Reimbursing
A provision in the Federal Unemployment Tax Act (Section 3309) provides for 501(c)(3) organizations to opt out of the tax system and reimburse the state only for those claims/benefits paid out. As a reimbursing employer your employees still get their benefits—you just pay the state for the cost of the claims rather than pay the taxes.
A nonprofit employer should look at their average annual claims costs vs. the amount they pay in SUI taxes to determine if reimbursing would save them money.
For example, a primary care facility in Alaska with 50 employees may pay over $92,000 in unemployment taxes, but their claims typically average $45,000. By reimbursing the state for the claims rather than pay SUI taxes, this facility could save over $47,000 a year.
Disadvantages of Reimbursing
A reimbursing employer can only anticipate its liability for claims. The successful reimbursing employer knows to track its annual claims costs and budget appropriately for unemployment expenses. Organizations should learn about the base period and what a typical claim costs so they can set aside an adequate amount of money to cover unemployment benefits (generally the maximum claim is 26 weeks). It’s also important to “over estimate” so that unanticipated layoffs are covered if a grant doesn’t go through or programs have to be cut.
Reimbursing employers are responsible for all the unemployment claims paid to their former employees by the state, no matter the amount. Also, reimbursing employers do not get “relief of charges.” This means that if an employee resigned from your organization, went to work for another company and was terminated, then filed for unemployment, you could now be charged a portion of their benefits (even though they voluntarily left you).
Third-Party Reimbursement Options
Approximately 4,000 nonprofits belong to different nonprofit unemployment programs throughout the country. These programs have additional features an organization may not be able to get on its own.
Initially they help the nonprofit file the paperwork with their state to become a reimburser, and then they handle the reimbursement payments to the state.
Other features vary, but may include member-owned reserve accounts, stop-loss insurance (which protects the members’ account from unusually high claims), claims management services to reduce costs, training workshops, and personnel services programs.
Representatives from the nonprofit membership typically advise unemployment grantor trusts, but unemployment programs vary in their administration. You can search the web for organizations that provide special unemployment programs for nonprofit agencies.
Making an educated decision for your unemployment coverage
Nonprofits with less than a million in gross annual payroll, or agencies that have high turnover, may not be the best candidates for reimbursing status.
It is also important to have a dedicated staff person to handle claims. Once a claim is filed, the nonprofit must follow up quickly if they want to protest a claim. Keeping good documentation is critical to a successful outcome. Claims management services, offered by several grantor trusts, help keep claims costs low while providing high-level unemployment expertise.
The goal of reimbursing is to save money while maintaining financial stability. Realistically anticipating that you will have claims and budgeting for them is essential. Make sure your annual budget designates funds to pay for annual unemployment claims.
Grantor trusts help the nonprofit set up its own reserve account and handle the payments to the state, thus reducing staff time for the nonprofit. The stop-loss insurance feature with some grantor trusts also reduces a nonprofit’s exposure if claims are high.
All states have a deadline to change from taxpayer to reimburser status, generally between November and January. To find out your state’s deadline contact the state unemployment department or search their website. Most states also require that you “opt out” for a minimum of two years before you can return to the tax system.
Evaluate the Opportunity
The bottom line on unemployment coverage is to investigate your options and compare costs. Since 501(c)(3) organizations have an option, it makes financial sense to evaluate whether paying taxes, reimbursing on your own, or joining a trust is the best way for your organization to save money safely and securely.
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