Unpaid State Debt to the Federal Government Could Increase Payroll Taxes for Businesses

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.

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

And then the COVID-19 pandemic hit in 2020, permanently or temporarily closing businesses and pushing states to recent record-highs in unemployment — 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 are three of the country’s most-populous states with a lion’s share of the U.S. workforce — 14 million workers just in California. The seven other states that had not paid back their Title XII loans before interest began accruing Sept. 6, 2021 were, Illinois, Massachusetts, Minnesota, Colorado, Connecticut, Pennsylvania and New Jersey.

Update as of 5/1/22: Minnesota's governor signed a bill into law that allocated $2.7 billion to repay the federal unemployment insurance loans and replenish the state's UI Trust Fund. This impacts the base tax rate, lowering it to 0.1% from 0.5% for 2022, so employers who already paid their first quarter UI tax are due a refund or credit from the state Department of Employment and Economic Development.

So, how does this impact the finances of a business? In many states that owe the federal government money for supporting their SUI programs, the states pass on the debt to businesses in the form of higher SUI payroll tax rates.

For example, Illinois finished off 2021 owing the federal government $4.2 billion. When it released its SUI tax rates for 2022, the minimum on businesses rose 0.05% to 0.725% while the maximum rose to 7.625% (up 0.75% from the previous year). The new employer rate (the rate a new business will pay for a year until it has employment data) rose 0.35%, while the wage base (the limit on the amount of salary subject to SUI tax) remain unchanged at $12,960.

Connecticut, meanwhile, has announced a bipartisan proposal to address the fact that for 48 of the past 50 years the Constitution State borrowed money to take care of its responsibility to its unemployed. The proposal that the state government would like to have in place by 2024 includes the following: the taxable wage base would go from its current $15,000 to $25,000. If the state’s current minimum tax rate (0.5%) is still in effect in 2024, then a business could pay $50 more per employee than in 2022. It also could pay $50 less under the proposed new minimum rate. However, the maximum rate would nearly double in percentage, leaving a high-turnover business paying $2,500 per employee ($1,350 more than in 2022).

Further affecting the cost of doing business in a state with an outstanding balance on a Title XII advance is the impact on the Federal Unemployment Tax Act (FUTA) credit. The FUTA tax goes to build the Federal Unemployment Trust Fund, which provides the money that states request as part of their Title XII advance. So, a business covered by its state UI program pays a FUTA tax of 6.0% on the first $7,000 of an employee’s wages subject to FUTA, but they generally can get a credit on 5.4% of that amount by filing Form 940.

However, if a state has an outstanding loan balance to the federal government on its Title XII advance as of Jan. 1 for two consecutive years — and does not repay the full amount by Nov. 10 of the second year — the state risks becoming a FUTA credit reduction state. Basically, all businesses in the state are then impacted by a drop of 0.3% per year in the credit rate until the debt is repaid in full. So, if your business is in a state that has no Title XII debt, your entire FUTA levy would be a maximum of $42 per employee after filing for the credit (Form 940). If your state recently was designated as a FUTA credit reduction state, you would pay a maximum of $63 per employee.

It doesn’t seem like much money — a little more than $400 annually for a business with 20 employees in a FUTA credit reduction state as compared to one in a state with full FUTA credit ($1,260 rather than $840). Consider, however, a business with 50 employees in the same two states? It’s now a $1,050 more per year.

Now, you’ve had a good year and you’re considering doubling in size to 100 employees, but your state is in its second year of being a FUTA credit reduction state. So, the credit is now down to 4.8%. It will now cost you $84 per employee compared to $42 in a non-credit reduction state, so those extra 50 employees are costing you twice as much ($4,200 instead of $2,100) per year in FUTA taxes.

California finished 2020 and 2021 in debt to the federal government, so a credit reduction is expected in 2022 and an increase in payroll taxes in 2023. It is expected that, by 2024 and after several credit reductions, businesses in the state 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.

Many states recognized this and 30 used funds the federal government provided all states through the Coronavirus Aid, Relief and Economic Security (CARES) Act of 2020, the American Rescue Plan Act of 2021 and employer payments to pay off or pay down their unemployment debts. West Virginia retired the $185 million it owed and was able to add several hundred million to its UI trust fund. In November 2021, Texas also repaid its Title XII loans, leaving $20 million in accrued interest. Connecticut, as noted above, is taking steps to address the issue of constant SUI shortfalls through legislation.

Other states have gone the route of issuing bonds. Illinois did this after the Great Recession in the late-2000s, but it took five years to repay and they had to hike taxes while cutting UI benefits.

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