Businesses in FUTA Credit Reduction States of N.Y., CA, and CT Face Increased Payroll Taxes

In the build-up of starting a new business or even expanding one, don’t forget about the cost of unemployment. The excitement doesn’t have to be tempered, but financially speaking, the topic needs to be considered.

Why? If you’re living in a state that is in debt to the federal government — specifically, around failure to repay in full its Title XII unemployment compensation loan — your cost of doing business most likely is going up.

The U.S. Department of Labor announced that California, Connecticut, and New York, as well as the U.S. Virgin Islands, are FUTA Credit Reduction States, which means there is a reduction in the Federal Unemployment Tax Act (FUTA) credit of 0.6%. For the U.S. Virgin Islands, it is a 3.9% reduction in the credit.

This results from the state having an outstanding loan balance to the federal government on its Title XII advance as of Jan. 1 for two consecutive years — and has failed to repay the full amount by Nov. 10 of the second year.

Why Do States Borrow from the Federal Government?

Borrowing from the federal government to supplement shortfalls in state unemployment insurance (SUI) trust funds is nothing new. Consider Connecticut, which has had an insolvent UI trust fund 96 percent of the time during the past half-century.

When the COVID-19 pandemic hit in 2020, businesses either permanently or temporarily closed and states saw their unemployment numbers soar to record-highs — New York peaked at 15.9 percent (3.4 million claimants in May 2020), according to the state Comptroller webpage, and Illinois hit 16.3%, according to the Illinois Department of Employment Security.

States turned to the federal government for enormous sums of money to make up for shortfalls in their SUI trust funds. California borrowed nearly $20 billion, New York got $9 billion, and Texas needed nearly $7 billion. This isn’t surprising considering these states support the lion’s share of the U.S. workforce — 14 million workers just in California.

How Does Unpaid Title XII Debt Impact Businesses?

Many states that owe money to the federal government for supporting their SUI programs tend to pass on the debt to businesses in the form of higher SUI payroll tax rates.

New York enters 2025 owing the federal government $5.5 billion, California owes a projected $22.7 billion. In contrast, Connecticut actually paid off its debt and was not subject to a credit in 2024, but has since borrowed again and because the state had outstanding balance on Jan. 1 for four straight years, they are once again subject to a potential credit reduction.

Doing the Math on FUTA Tax Rate

All states are subject to a 6.0% FUTA tax rate, up to $7,000 per employee. Businesses receive a 5.4% credit against the FUTA rate from the IRS for making timely SUI payments throughout the year. So, 6.0 minus 5.4 is 0.6, and this the FUTA percentage rate most businesses receive.

However, for FUTA Credit Reduction States in 2025 (California and New York, specifically), the normal credit of 5.4% is reduced by 0.6%, leaving the credit reduction for them at 4.8%. Take the 6.0% FUTA tax rate and subtract 4.8% to get 1.2%, which is the FUTA rate for N.Y. and California for 2025. Connecticut's circumstance warrants a potential 1.2% credit reduction because of the four straight Jan. 1 having an outstanding balance on their loan.

To simplify it, most ERs in every state except CT, CA ,and N.Y. will pay a maximum of $42 per employee ($7,000 x 0.6%). Employers in CT, CA, and N.Y. will pay a maximum of $84 per employee ($7,000 x 1.2%).

Let's say you have five employees and are doing business in N.Y., Connecticut, or California: You will pay $420 more for your employees in 2025 than the same business with five employees in a non-FUTA Credit Reduction states, who will pay $210 in the same year. It doesn't seem like much difference, but what if you have 50 employees? You're now paying $4,200 more in 2025 in the FUTA Credit Reduction States, while the same-sized business in another state is paying half that.

The three FUTA Credit Reduction States potentially could face additional penalties in 2025: the Benefit Cost Rate. This add-on is different for each state - California is 3.7%, Connecticut is 0.8%, and New York is a 1.1% add-on. States can apply for a waiver of the add-on BCR by July 1, but without any relief, the FUTA credit reduction in each state could be 4.9% in California, 2.0% in Connecticut, and 2.3% in New York.

Rethinking Business in a FUTA Credit Reduction State

Let's use California, which has the most debt outstanding to the Title XII program, as an example. If California does not retire its Title XII debt until 2032, employers could be paying more than $300 per employee annually in FUTA taxes for the next seven years if businesses pick up paying the entire loan.

So, the potential costs of doing business in a state that has outstanding Title XII loan debt to the federal government would have to be part of the conversation when weighing the financial risks of starting a business or expanding an existing one.

Starting a business and expanding one are crucial to the health of a nation’s economy. However, where you want that business to be located could, in part, depend on the state of that state’s short- and long-term financial well-being.

Paychex Can Help

Employer payroll responsibilities may seem overwhelming, especially with the rules continually changing. To ensure that you do things correctly, consider outsourcing payroll to a payroll service provider such as Paychex.

Other resources

• Read this article for tips on starting a business
• Check out our Guide to Employment Taxes