While often overlooked, unemployment insurance (UI) tax is a unique and interesting business obligation, because it is the tax over which a company has significant control. The ability to control both the size of the base exposed to taxation as well as the tax rate itself means planning opportunities exist here that are not found in other forms of taxation.
- It may be altogether avoidable, depending on your state, business structure and appropriate use of independent contractors, and
- It is highly responsive to behaviors and actions that you can control, monitor and measure.
Unlike a sales or income tax, unemployment insurance does not directly tax revenue or profitability. Rather, it is similar to an ad valorem tax in that it is a type of tax on productive capacity. But unlike an ad valorem tax, a company has control over the base on which that tax is levied. UI is based on a measure of payroll and smart job structuring and hiring decisions allow a company to maximize revenue with a certain sized workforce while minimizing payroll exposed to taxation.
Unlike other taxes, unemployment insurance tax rate is experience rated. This means that, in most states, a company’s rate is based largely on its previous success in defending UI claims. Because of this experience rating aspect of UI, implementing effective changes today benefits not only the current quarter, but the years to come.
Companies that operate with UI consequences in mind can realize benefits beyond a lower tax rate. Often they see improvements in HR and communication processes in addition to becoming more efficient due to some standardization. In implementing changes, proactivity is the key and the human resources department is where most of the work must be done – especially in the areas of position announcement, selection, communication and retention.
It was mentioned that in the appropriate use of independent contractors can help a company avoid unemployment taxation altogether. But “appropriate” must be understood in light of UI laws in the state(s) where it does business. Each state’s law regarding independent contractors must be understood or the company could face contractors being reclassified as employees.
However, if properly managed, unemployment insurance can be reduced until it’s a relatively small business obligation. But to accomplish this, companies must implement change with an in-depth understanding of their state’s UI laws, policy and practices. Thus, company’s should consider consulting with experts in each new state where they are doing business, rather than learn state specific legislation as mistakes are made.