September 27, 2014  
 
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Unemployment Insurance

 

An Unemployment Insurance System Primer

It takes a bite out of your cash every payroll, but do you really understand what unemployment insurance is and how the system works?

If you own a business, you need to understand what unemployment insurance is and how it works.
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This article is a primer on understanding unemployment insurance.

Let's start with the history of the unemployment insurance system.

The unemployment insurance system was created more than 70 years ago as "an economic line of defense against the effects of unemployment, for not only the individual, but also the local community."

Operating as both a federal and state program, the goal of unemployment insurance is to provide financial assistance to a person who becomes unemployed through no fault of his or her own.

The unemployed individual signs up for unemployment benefits with their local state workforce agency, and, assuming they qualify, they begin receiving unemployment checks to alleviate the loss of wages due to unemployment.

Unemployment insurance benefits allow the person to maintain basic necessities such as food, clothing and shelter while they look for a new job.

Many unemployed individuals believe they are entitled to unemployment benefits because they have already paid the money in while they were employed.

This is not the case. There is no such thing as an employee unemployment insurance tax. No deductions are made from employees' wages to finance the unemployment insurance system, although one can of course argue that employers might pay employees higher salaries if they did not have to pay these taxes.

The program is funded exclusively by taxes paid by employers based on the amount of wages they pay to employees.

Each employer's unemployment insurance tax rate is different. The tax rate an employer pays is adjusted periodically based on the number of prior claims for unemployment benefits that have been filed against that employer.

An employer that has many former employees filing for unemployment insurance will typically see an increase in their tax rate, simply because they are contributing to a higher share of benefits claims than many of their peers.

Now, you have a basic understanding of how unemployment insurance works. In the future, we will cover other topics related to unemployment insurance, including how you can take steps to ensure that your tax rates are not unnecessarily high.

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Conversation Board

Please leave a comment below if you have questions or advice regarding unemployment insurance. Thanks.

Patricia C. 2/9/2010

Does a small business get billed for the unemployment benefits a person receives? E.g., a part-time employee receives $161 a week in unemployment benefits. Where does this ultimately come from? I understood that the company has to pay it back to the State.

Ken Gaebler 2/11/2010

Patricia, No single company would pay that $161 directly, but every employer in the state pays it indirectly. Here's how unemployment works. Whenever they process payroll, business owners have to pay a certain percentage of the payroll as unemployment payroll taxes. That money ends up in a pool of money that is subsequently used to pay unemployment benefits. Each employer has a different percentage that they have to pay, and the percentage is based on things like how many of their employees have claimed uninsurance benefits in the past. There are some businesses out there that have paid a lot of unemployment payroll taxes over the years even though they have never had an employee leave and then file for unemployment. It's not really fair, but that's the way the unemployment system works.

Jan 2/19/2010

I have a small training company. I have been in business for ten years. 2009 was very slow. I did not work for 4 months. I have not worked this year. Are there any benefits a small business owner can claim when they are unemployed?

Ken Gaebler 2/19/2010

Jan,

Unfortunately, the answer to "Can I collect unemployment if I am self-employed?" is that you typically would not be eligible for unemployment. If your business is incorporated and you have been paying unemployment taxes, you may be eligible. Check with your local unemployment benefits office for your state.

Assuming you've already looked into that, there aren't any other good options that I know of -- there's no government-supported safety net for struggling entrepreneurs. Hope things turn around for you soon!

Jeff 5/20/2010

I've recently been laid off and am considering helping a friend start up a company. As there is no current cashflow, the only compensation that could be offered would be in the form of equity. Will I still be able to file for unemployment in this instance? Does the equity-based compensation figure into any of this? Love the site by the way, answered a few other questions I had as I ease my way into the entrepreneurial world.

Ken Gaebler 5/21/2010

Jeff, I hate to punt on the question but it's probably best to ask the state unemployment insurance benefits people for your state. In most states, you can still collect unemployment for working part-time but your case is a little different since you are getting non-cash compensation. A couple of things to think about are pushing the equity grant to a future date or giving yourself an option to buy equity. This will avoid the equity being taxable. In addition, equity in a startup is illiquid and risk, so I would apply a heavy discount to the value of the equity. Don't fall into the trap of overvaluing the equity and then being liable for taxes on something that may end up being worthless.


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