Employers pay most unemployment tax; employees pay a portion in some states
In most of the United States, employers pay the full unemployment tax. The employer withholds nothing from your paycheck for unemployment insurance. However, three states — Alaska, New Jersey, and Pennsylvania — require employees to contribute as well. In those states, the employer still pays the larger share, but you see a deduction on your pay stub.
The amount employers pay varies by state and by their industry. States set their own tax rates based on how many former employees have filed for unemployment benefits. An employer in construction, where layoffs are common, typically pays a higher rate than one in a stable industry. New employers usually pay a standard rate until the state has enough history to calculate their individual rate.
The federal government also collects a small unemployment tax from employers to fund administration and to support state programs during recessions. This federal tax is the same across all states and all employers.
Key Takeaways
- Employers in all 50 states pay unemployment tax; employees in Alaska, New Jersey, and Pennsylvania also contribute through payroll deductions.
- State unemployment tax rates depend on the employer's industry, history of layoffs, and how long they have been in business.
- The federal unemployment tax rate is uniform nationwide and funds program administration and emergency support.
- New employers typically pay a standard rate until the state builds a record of their hiring and separation patterns.
- An employer's tax rate can change year to year based on how much unemployment their former workers have drawn.
How state unemployment tax rates are calculated
Each state sets its own unemployment tax rate for employers based on a formula called the experience rating or merit rating. The state looks at how much unemployment insurance the employer's former workers have received over a set period — usually the past three years. If many former employees filed for benefits, the employer's rate goes up. If few did, the rate goes down.
States also set a minimum and maximum rate. An employer cannot pay less than the floor or more than the ceiling, even if their history would suggest otherwise. These ranges vary by state. Some states have a floor of 0.1 percent and a ceiling of 5.4 percent; others use different numbers.
New employers who have not yet built a history pay a standard rate set by the state, usually somewhere in the middle of the range. Once the state has tracked their payroll and separations for a year or more, they move to the experience-rating system.
Federal unemployment tax and what it funds
Employers also pay a federal unemployment tax, collected by the Internal Revenue Service. The federal rate is 6 percent of the first $7,000 of each employee's annual wages. However, employers receive a credit of up to 5.4 percent if they pay their state unemployment tax on time, which means the net federal tax is usually 0.6 percent.
The federal tax funds the administrative costs of state unemployment programs and provides loans to states whose unemployment trust funds run low during recessions. When a state's fund is depleted and many people are drawing benefits, the federal government can lend money so the state can continue paying claims without raising employer taxes when ready.
The federal tax is the same for all employers in all states. It does not change based on industry or the employer's history of layoffs.
Why the three states with employee contributions are different
Alaska, New Jersey, and Pennsylvania require employees to pay part of the unemployment insurance cost. In Alaska, employees contribute 0.58 percent of wages. In New Jersey, the rate ranges from 0.08 to 0.62 percent depending on the employer's industry and experience rating. Pennsylvania's employee rate is 0.06 percent.
These three states implemented employee contributions at different times and for different reasons. New Jersey and Pennsylvania have long histories of shared funding. Alaska added employee contributions more recently. In all three states, the employer still pays a larger share than the employee.
Even in these states, the employee contribution is deducted from your paycheck before you see it — you do not send money separately to the state. Your employer handles the withholding and sends both the employer and employee portions to the state unemployment fund.
How unemployment tax affects your employer's costs
Unemployment tax is a direct cost to the employer and does not reduce the wages they owe you. If an employer pays 2 percent in state unemployment tax plus 0.6 percent in federal unemployment tax, that is 2.6 percent added to their total payroll expense. On a $50,000 annual salary, that amounts to $1,300 per year in unemployment taxes for that one employee.
Because the rate depends on how many workers have filed for benefits, employers have an incentive to contest claims they believe are invalid or to document performance issues that might affect whether a former employee is found to have been laid off versus fired for cause. A worker fired for misconduct may not be able to draw unemployment benefits, which keeps the employer's rate from rising.
Some employers purchase unemployment insurance from private carriers instead of paying into the state system, though this is only available in a few states and is uncommon. Most employers pay into the state fund.
What happens if an employer does not pay unemployment tax
Employers are required by law to pay unemployment tax. States have enforcement mechanisms to collect unpaid taxes, including liens on business assets, wage garnishment of the business owner, and criminal penalties in cases of deliberate evasion.
If an employer fails to pay and later lays off workers, those workers can still file for unemployment benefits. The state pays the benefits from its fund and then pursues the employer for reimbursement. This means unpaid unemployment taxes do not prevent workers from receiving benefits — it creates a debt the employer owes to the state.
Employers who are behind on unemployment taxes may also lose their business license or be barred from bidding on government contracts, depending on state law.
Self-employed workers and unemployment tax
Self-employed people do not pay unemployment tax and are not covered by unemployment insurance. If you are a sole proprietor or partner in a partnership, you cannot draw unemployment benefits even if your business closes or fails.
Some self-employed workers incorporate their business and become employees of their own corporation. In that case, they would pay unemployment tax like any other employer and employee, though the practical benefit is limited since they control whether they lay themselves off.
Gig workers and independent contractors also do not pay unemployment tax and have no unemployment coverage. This is one of the key differences between contractor status and employee status.
Frequently Asked Questions
Can an employer reduce their unemployment tax rate by laying off workers?
No. The experience rating looks backward at how much unemployment was drawn, not forward. Laying off workers increases the rate because those workers will likely file for benefits. An employer cannot lower their rate by firing people; they lower it by retaining workers and having few claims filed against their account.
Do I pay unemployment tax if I work part-time?
Yes, your employer pays unemployment tax on your wages whether you work full-time or part-time. In Alaska, New Jersey, and Pennsylvania, you also contribute through payroll deduction. The amount is based on your gross wages, not your hours.
What if I work for multiple employers?
Each employer pays unemployment tax on the wages they pay you. You are covered under each employer's account. If you are laid off from one job, you can file for benefits based on that employer's wages. In the three states with employee contributions, each employer withholds from your pay separately.
Does unemployment tax explore to bonuses and commissions?
Yes. Unemployment tax is calculated on all wages, including bonuses, commissions, and other compensation. The federal tax applies only to the first $7,000 per employee per year, but state taxes typically explore to all wages up to a state-set maximum.
Can a nonprofit organization avoid paying unemployment tax?
Most nonprofits must pay unemployment tax like any other employer. Some states allow certain nonprofits to reimburse the state directly for benefits paid to their former workers instead of paying into the regular system, but this is optional and uncommon. The nonprofit still bears the cost.