How to Reduce the Cost of Unemployment Insurance for Small Business

by Neal Frankle, CFP ®

If you have a small business your cost of unemployment insurance may go unnoticed but it shouldn’t. Over time it can add up to a sizeable chunk of change. The good news is that you can take a few easy steps now to save money and significantly reduce this business insurance cost.

The Battlefield

First understand that Unemployment Insurance is both a Federal and state program. Both bodies levy taxes (Federal/ state UI tax) against you if you have employees.

The Feds use the Federal Unemployment Tax Act (FUTA) to get what’s inside your wallet. It authorizes the IRS to collect the tax. The Federal revenues are used to pay for job service programs and it also covers up to ½ the cost of extended unemployment benefits any time such a program is enacted.

The FUTA tax is convoluted and you get a credit for state unemployment tax you pay. Suffice it to say that at the end of the day, you pay .6% on the first $7,000 of wages or $42 per employee per year. You can see that it’s not a huge deal.

The money the state collects is used to pay benefits. Employers pay more into that system. Of course the rate differs by state. But depending on where you run your small business, the unemployment insurance levy can add up. In California, the maximum rate is 6.2% of the first $7000 or $434 per employee. You can see that as the number of employees you hire grows, the rate you pay is increasingly important.

How to Keep Your Unemployment Insurance Costs Low

There are two practical ways you can reduce your unemployment insurance premiums:

1. Hire Contractors

Rather than hire employees, hire independent contractors. This will save you all kinds of money and if you can do this legally, I am all in favor of it. The way to make sure you stay on the right side of the law on this is to understand the rules and make sure you adhere to them. Basically, for someone to be an independent contractor, they must satisfy three requirements:

Behavior

Do you have control or the right to control what the person does, when they do it or how they do it? If so, they are an employee and not a contractor. Sorry. If you want the person to be a contractor, they must have more control – and that means you have to give up some control.

Money

Does the person actually run a business? Do they have their own tools? Do they make business investments? Do they have business risk? Do they have multiple clients or are you the only one? These questions also help determine if the person is an employee or contractor.

Contracts and Benefits

First if you want to establish an independent contractor relationship with someone you must have a contract. If you don’t, you may find it difficult to prove your case.

Next, do you provide retirement plans or health plans for the person? Do they receive paid vacations? If you answer “yes” to any of these questions it would indicate that the person is an employee rather than an independent contractor as well.

If you think you may be able to work with independent contractors rather than employees, you should speak with your tax expert and make sure. The last thing you want to do is to run into trouble with the Federal or state government. You might save some money over the short-term, but if you don’t do this correctly it will cost you much more down the road.

2. Fight Unemployment Claims

The second way to keep your unemployment insurance tax to a bare minimum is to monitor your claims and fight them when appropriate. Here’s a short story to illustrate how important this can be.

Shortly after I graduated from college I found myself in charge of a small but rapidly growing technology company. Before you knew it, we had over 50 people working for us. Since many of the jobs were entry level, we had our fair share of turnover.

I never fired anyone without cause but that didn’t stop some of those individuals from making unemployment insurance claims. In one case (I’ll never forget) the women moved away to go to college. We even offered her a job at her new location but because she became a full-time student, she felt she didn’t have time to work. That was her prerogative of course but since she made the decision to quit, she didn’t qualify for benefits according to my understanding of the law.

But this woman was clever. When she made her claim, she provided a false employer address and as a result, we didn’t hear about the claim soon enough to respond. Because we failed to respond, the court found in her favor and awarded her the benefits.

The only way I found out about this was when I noticed that our UI rate had increased- a full year later. Of course I appealed the decision. Fortunately we won. Our rate was reduced and the former employee had to repay her ill-gotten loot.

So watch your UI rate and compare it to the previous quarter. If it rises, find out why.

Just because the government has a lot of power, it doesn’t mean you don’t have any at all. Exercise your rights. Hire contracts when practical and watch your UI levies. These two steps will save you a nice chunk of change over the long run.

What other tips can you share to help small business owners save on taxes or other costs?

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