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As of July 1, 2020, 13 jurisdictions (California, Colorado, Delaware, Hawaii, Illinois, Kentucky, Massachusetts, Minnesota, New York, Ohio, Texas, the Virgin Islands and West Virginia) have applied for and been approved to receive federal unemployment insurance (UI) Title XII advances (UI loans). Connecticut had previously received approval for a UI loan but has since been removed from the list. (Title XII Advance Activities Schedule, UI Department of Treasury website.)

As of July 1, 2020, California, Illinois, Kentucky, Massachusetts, New York, Ohio, and Texas currently have outstanding federal UI loan balances. Virgin Islands continues to carry a federal loan balance on a loan that has existed since 2009. (US Department of Labor UI trust fund loans.)

US rate of unemployment 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 11.1% in June 2020, down from the May 2020 rate of 13.3%. Total nonfarm payroll rose by 4.8 million in June. (USDL-20-1310, the employment situation for June 2020, released July 2, 2020.

Federal-state extended benefit (EB) program now in effect for all states except South Dakota

Due to the states' currently high UI benefit rates, the US DOL extended benefit (EB) trigger notice for July 5, 2020, reflects that all states except for South Dakota have triggered an additional 13-weeks in UI benefits for individuals who have exhausted their previous state and federal UI benefits. Several states have UI benefit rates that are high enough that they have also triggered an additional 7 weeks of extended benefits, for a total of 20 weeks of extended benefits.

Under federal law, the EB program offers up to an additional 13-20 weeks of UI benefits to individuals who have exhausted both their regular unemployment benefits and 13 weeks of the Pandemic Emergency Unemployment Compensation (PEUC) assistance.

Background on federal UI loans

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 can apply for federal loans to bolster their trust fund balances so that the payment of UI benefits is not interrupted. They may also opt for other funding sources, such as the issuance of state bonds.

Federal UI loans taken in 2020 are interest free if repaid by the end of 2020. 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. At that time, most 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 that 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 have been fully funded by the federal government and will not affect state UI trust fund balances.

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