Unemployment tax is a payroll tax that employers pay to fund state unemployment insurance programs

Unemployment tax is money that employers contribute to a state fund. That fund pays benefits to workers who lose their jobs. You do not pay unemployment tax as an employee — your employer does. The tax comes out of the employer's operating budget, not your paycheck.

Each state runs its own unemployment insurance program and sets its own tax rate. The federal government also collects a small unemployment tax from employers, which funds administrative costs and provides loans to states when their funds run low. The result is that unemployment tax has both a state and federal component, though the state portion is much larger.

Key Takeaways

  • Employers pay unemployment tax to their state; employees do not pay it directly from their wages.
  • State unemployment tax rates vary by state and by industry, ranging from roughly 0.5% to 5.4% of payroll in most states.
  • The federal unemployment tax (FUTA) is a flat 6% on the first $7,000 of each employee's annual wages, though employers receive a credit that typically reduces it to 0.6%.
  • An employer's state tax rate can change based on how many former employees have filed for benefits — this is called experience rating.

How state unemployment tax rates are set

Each state has a minimum and maximum unemployment tax rate. Most states set rates somewhere between 0.5% and 5.4% of an employee's wages, though some states go higher. The state applies this rate to a portion of each employee's annual salary — often the first $7,000 to $42,000, depending on the state.

A key factor in your state's rate is experience rating. This means an employer's tax rate can go up or down based on how many of its former employees have filed for unemployment benefits. An employer with a history of laying off workers or having high turnover pays a higher rate. An employer with stable employment and few claims pays a lower rate. This creates an incentive for employers to keep workers on the job.

New employers often pay a standard rate until they have been in business long enough for the state to calculate their experience rating. The exact timeline varies by state — some states calculate it after one year, others after three.

Federal unemployment tax and how it works

The federal government also taxes employers for unemployment insurance through the Federal Unemployment Tax Act (FUTA). The federal rate is 6% of the first $7,000 of each employee's annual wages. However, employers receive a credit of up to 5.4% if they pay their state unemployment tax on time. This means the effective federal rate is usually 0.6% — the difference between 6% and the 5.4% credit.

States that have borrowed money from the federal government to pay benefits may not receive the full credit, which temporarily raises the effective federal rate for employers in those states. This is rare and typically happens only during severe economic downturns.

The federal tax funds the Department of Labor, which oversees state programs, and provides emergency loans to states whose unemployment funds are depleted. It does not directly pay individual benefits.

Who has to pay unemployment tax

Most employers pay unemployment tax, but there are exceptions. The rules depend on how many employees a business has and what type of business it is. Generally, employers with one or more employees must pay state unemployment tax. Federal unemployment tax applies to employers with a payroll of $1,500 or more in any calendar quarter, or who employ at least one person on any day in 20 or more weeks during a year.

Some employers are exempt. These include certain religious organizations, some government agencies, and a few other categories that vary by state. Self-employed people typically do not pay unemployment tax, though some states have begun requiring it for certain types of self-employment.

If you are unsure whether your employer pays unemployment tax, you can check your state's labor department website or ask your payroll or human resources department.

Why unemployment tax matters to you as an employee

Although you do not pay unemployment tax directly, it affects you when you lose your job. The money your employer paid into the state fund is what pays your unemployment benefits if you are laid off or let go through no fault of your own. Without this tax, there would be no insurance pool to draw from.

Unemployment tax also indirectly affects your wages. Some economists argue that because employers pay this tax, they may offer slightly lower wages than they would if the tax did not exist. However, this effect is difficult to measure and varies by industry and region.

The stability of your state's unemployment fund can also matter. If a state's fund runs low during a recession, it may borrow from the federal government, which can lead to higher tax rates for employers in future years — and potentially lower wage growth as employers adjust their budgets.

How unemployment tax differs from income tax withholding

Unemployment tax and income tax withholding are both payroll taxes, but they work differently. Income tax withholding comes out of your paycheck and goes to the federal or state government based on the W-4 form you fill out. Unemployment tax does not come out of your paycheck at all — it is paid entirely by your employer.

Income tax withholding is meant to cover your personal income tax liability for the year. Unemployment tax is an insurance program that protects workers who lose their jobs. The two are separate systems with separate purposes and separate funding sources.

What happens to unemployment tax money

State unemployment tax money goes into a trust fund managed by your state's labor department or unemployment insurance agency. When someone files for unemployment benefits and is found to be may be able to access, the state pays them from this fund. The money is not held in a personal account — it is pooled with all the other tax revenue and distributed as claims come in.

If a state's fund runs low, the state may borrow from the federal government to continue paying benefits. Some states have had to do this during recessions. When a state borrows, it typically must repay the loan, which can lead to higher unemployment tax rates for employers in that state until the debt is paid off.

Federal unemployment tax money goes to the U.S. Department of Labor to cover administrative costs of the unemployment insurance system and to provide those emergency loans to states.

Frequently Asked Questions

Can I see how much unemployment tax my employer pays?

Your employer's unemployment tax rate is public information in most states and is available through your state's labor department or unemployment insurance agency website. However, the exact dollar amount your employer pays is typically private. You can contact your state's labor department to learn what your state's rate range is.

Does unemployment tax go up if I file for benefits?

Not directly for you personally, but it can affect your employer's rate. If you file for benefits and are found to be may be able to access, your employer's experience rating may increase, which can raise their tax rate in future years. This is one reason some employers contest benefit claims.

What if my employer does not pay unemployment tax?

If your employer is required to pay but does not, you can report it to your state's labor department or unemployment insurance agency. However, this does not affect your ability to file for benefits if you lose your job — the state will still process your claim. The state may pursue the employer for back taxes and penalties.

Do gig workers and contractors pay unemployment tax?

Most gig workers and independent contractors do not pay unemployment tax and are not covered by unemployment insurance. Some states have begun experimenting with portable unemployment benefits for gig workers, but coverage remains limited. Check your state's labor department website to see if your type of work is covered.

How often does my employer's unemployment tax rate change?

Most states recalculate experience ratings once per year, usually in the fall or early winter. Some states do it more frequently. The exact schedule depends on your state. Your employer's payroll or human resources department can tell you when rates are recalculated.