New York and California Businesses Face Increased Payroll Taxes Because Unpaid State Debt to Federal Government

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 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 fails 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, according to U.S. Treasury data as of Sept. 2, 2021. 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 entered 2023 owing the federal government almost $8 billion and California owed more than $18.5 billion. In contrast, Connecticut and Illinois began the year with balances owed to the Title XII program, but both paid off their debt in full to avoid a credit reduction and saved their employers substantial tax increases.

The SUI tax rates for 2024 are expected to be released between December 2023 and March 2024, which could change for N.Y. and California because of their designation as FUTA Credit Reduction states.

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 such as N.Y. and California, 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 2023.

To simplify it, most ERs in every state except CA and N.Y. will pay a maximum of $42 per employee ($7,000 x 0.6%). Employers in 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 either N.Y. or California: You will pay $420 more for your employees in 2023 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 2023 in N.Y. and California, while the same-sized business in another state is paying half that.

Business in a FUTA Credit Reduction State Could Get Expensive

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 by Nov. 10, 2024, businesses in the state — after several credit reductions — will be paying nearly $100 more per employee. If businesses pick up paying the entire federal loan, employers could be paying just about $270 per employee in FUTA taxes by the time it is paid off in 2032.

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