Tax News Update    Email this document    Print this document  

As of June 5, 2020, 11 states (California, Colorado, Connecticut, Hawaii, Illinois, Massachusetts, New York, Ohio, Texas, the Virgin Islands and West Virginia) have applied for and been approved for federal unemployment insurance (UI) Title XII advances (UI loans). As of June 5, 2020, California and New York currently have outstanding federal loan balances of $365,000,000 and $1,176,802,785, respectively. The Virgin Islands continue to carry a federal loan balance of $59,066,850 on a loan that has existed since 2009. (Title XII Advance Activities Schedule, UI Department of Treasury website; EY Payroll Newsflash Vol. 21, #221, 5-11-2020.)

US unemployment rate starts to fall as COVID-19-affected states and businesses begin to reopen

The US Bureau of Labor Statistics (BLS) reports that the rate of unemployment fell to 13.3% in May 2020, down from the April 2020 rate of 14.7%. Total nonfarm payroll rose by 2.5 million in May. (USDL-20-1140, the employment situation for May 2020, released June 5, 2020.)

Background on federal UI advances

Federal UI law requires states to continue to pay regular UI benefits, even when their UI trust funds are depleted. States with depleted trust fund balances apply for federal loans to bolster their trust fund balances so that the payment of UI benefits is not interrupted.

Federal advances taken in 2020 are interest-free if repaid by the end of 2020. (Reportedly, California quickly repaid its initial 2020 advance in May, then borrowed again.) Interest begins to accrue in 2021, and if a federal UI loan balance is still outstanding after two years (in 2022), employers are required to make payments toward the outstanding federal loan balance in the form of a federal unemployment insurance (FUTA) credit reduction that increases the FUTA taxes employers pay.

The last time the nation saw a substantial increase in UI benefit payouts was during the great recession of 2007 and 2008. The majority of states received federal loans to shore up their trust fund reserves and, at the peak in 2011, 21 states fell subject to the FUTA credit reduction. Once triggered, it can take years for the FUTA credit reduction to go away. California, for instance, began borrowing in 2009, and its loan balance was not repaid until 2018, subjecting California employers to the FUTA credit reduction for seven years (2011 to 2017). The Virgin Islands has yet to repay its loan balance from this period, and a FUTA credit reduction in 2020 is likely for Virgin Islands employers. See Figure 1 below.

Figure 1: FUTA credit reduction due to the 2007–2008 recession

Interest surcharges can further increase state unemployment insurance tax cost

Under federal law, the interest on a federal UI loan, or any other debt instrument (e.g., a state bond) used to fund UI benefits, cannot be paid from the states' UI trust funds, forcing many states to recover the cost from employers in the form of interest surcharges. These surcharges are paid in addition to the normal UI tax employers pay, and they cannot be counted as UI contributions for purposes of computing the allowable credit on the Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return.

FUTA credit reduction: the added burden of long-term debt

When a FUTA credit reduction applies, the maximum FUTA credit falls below 5.4%. To lose a portion of the maximum 5.4% FUTA credit means that the net FUTA tax rate rises above the normal 0.6%. For instance, if the maximum 5.4% FUTA credit is reduced by 0.3%, the net FUTA rate increases from 0.6% to 0.9% [6.0% - (5.4% - 0.3%) = 0.9%].

States are given the option of accepting a federal UI loan to augment their UI trust funds. If states do not repay these federal loans within a certain time frame, employers in those states are required to assist in repaying these loan balances through funds obtained from the FUTA credit reduction.

Specifically, if a state has an outstanding federal UI loan balance on January 1 of two consecutive years and fails to repay the entire balance by November 10 of the second year, employers in that state are subject to a reduction in the maximum 5.4% FUTA credit. With certain exceptions, the credit reduction increases in 0.3% increments each subsequent year the loan balance remains unpaid. The additional FUTA tax per employee that is the result of this FUTA credit reduction can be substantial, particularly if federal UI loan balances linger over several years. (See Figure 2.)

Figure 2: FUTA credit reduction effect before add-on

Federal law discourages states from carrying their federal unemployment insurance loan balances over several years by further reducing the FUTA credit beginning in the fifth year of the loan. This add-on to the FUTA credit reduction is referred to as the Benefit Cost Rate (BCR).

The BCR penalty may be waived if the jurisdiction's governor submits an application to the US Secretary of Labor no later than July 1 of the penalty year; and the jurisdiction takes no action (legislative, judicial, or administrative) during the 12-month period ending September 30 that would reduce unemployment insurance trust fund solvency during that same time period.

Should the BCR add-on be waived, as is normally the case if the conditions are met, another penalty, referred to as the 2.7 add-on, can apply if the jurisdiction's average unemployment insurance tax rate is inadequate. The 2.7 add-on penalty rate cannot be avoided or waived once activated.

Ernst & Young LLP insights

In addition to the possible increases in future FUTA taxes, employers should also anticipate future increases in state UI taxes to replenish state trust funds. Calendar year 2021 SUI tax rates will most likely be impacted by falling state UI trust funds, even though most states have agreed that employer SUI accounts will not be directly charged for UI benefits paid in connection with COVID-19.

Note, however, that the additional $600 Pandemic Unemployment Assistance (PUA) payments are fully funded by the federal government and will not affect state UI trust fund balances.

———————————————

———————————————
ATTACHMENT

EY Payroll News Flash