How should your nonprofit fund unemployment claims?The U.S. Department of Labor created unemployment insurance to help workers who lose their jobs through reasons beyond their control, such as a layoff. Most for-profit businesses pay federal and state taxes to fund this insurance program. Nonprofits, however, are exempt from federal unemployment taxes — which means that your nonprofit must choose how to fund unemployment claims.
Possible unemployment claims are a reality for any organization. As a nonprofit, you have three options to prepare for those potential claims:
Pay state unemployment tax
States fund unemployment programs at different levels. These levels are based in part on the number of unemployment claims in a given year, ranging from as little as 0.1 percent to more than 10 percent of each employee's taxable wages. States with a large number of unemployment claims — such as those that recently experienced an economic recession — typically compensate by increasing the employer unemployment tax burden.
In some states, you'll pay a set tax rate every year regardless of how many of your former employees file unemployment claims. In others, the tax rate is determined differently. In Texas, for example, your organization's annual state unemployment tax percentage rate is partially determined by actual claims paid to your former employees over the past three state fiscal years.
Paying state unemployment taxes likely makes sense if your nonprofit has:
- Fewer than 10 employees
- Staffing needs that fluctuate greatly
- Frequent layoffs
Pay into a trust that can be accessed in the event of an unemployment claim
Another option is to make regular contributions to a trust, which can then be tapped to reimburse the state for any claims paid to your former employees. Two such trusts are the Unemployment Services Trust (UST) and the 501(c) Agencies Trust. These trusts allow nonprofit employers to make payments toward future claims, while still shielding themselves from the ups and downs of the shifting tax burden. Some trusts offer a stop-loss insurance feature, which offers protection from unusually high unemployment claims.
Reimburse the state for any unemployment claims
As a final option, you may choose reimbursement. In this case, your nonprofit opts out of insurance or trust payments and instead reimburses the state directly for any claims paid to your former employees. Reimbursement is typically most appropriate for nonprofits that have a history of stable staffing and few unemployment claims. Caution is required, though. If your organization is small or lays off or terminates a large number of employees, you could pay more in reimbursement than you would have paid in unemployment taxes.
The risks of noncompliance
Your state has legal recourse if your nonprofit doesn't participate or follow through with one of the options described above. In fact, noncompliance with unemployment taxes or reimbursement may incur criminal liability — and repeated failure to comply may result in felony charges.
Clearly, the consequences of noncompliance can be much more damaging than paying any claims might be. Whether your nonprofit chooses to pay state unemployment taxes, pay into a trust or set aside funds for reimbursement, thinking ahead is simply a smart way to prepare for the future.
This article draws on the expertise of Grace Davies, a Minneapolis-based attorney with special interest in product liability, medical malpractice and employment discrimination.
U.S. Department of Labor: Unemployment insurance
Nolo: Should your nonprofit participate in its state unemployment insurance program? by Stephen Fishman (2013)
GuideStar: Alternatives to unemployment taxes for 501(c)(3)s by Cynthia Koral (2005)