Payroll Brass Tax: Unemployment Tax Rate Season, Part 1—Best Practices and Avoiding Pitfalls

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Mike Mahoney: Welcome to Payroll Brass Tax, the show where we demystify payroll, HR, and compliance so you can run your business with confidence. I’m Mike Mahoney, a shareholder in Ogletree’s Morristown, New Jersey and New York City offices, and the chair of the Employment Tax Practice Group, and today is the first of a two-part segment on digging into a piece of mail that can make or break your payroll budget for the year: your unemployment tax rate notice.
Whether you’re new to payroll or you’ve been at it for years, those notices can be confusing and expensive if you miss something. Joining me is Stephen Kenney, an Associate in Ogletree’s Dallas, Texas office, and a seasoned unemployment insurance and payroll compliance attorney.
Stephen, thanks for being here.

Stephen Kenney: Thanks, Mike. I’m happy to be here. This is one of those topics that’s easy to ignore until it costs you some real money.

Mike Mahoney: That’s definitely the truth. So, today’s format is simple, Stephen. We’re going to do some rapid-fire questions and clear answers that employers can act on. So, with that, let’s get started. So, the first question, what is unemployment tax rate notice?

Stephen Kenney: So, it’s a formal notice from your state workforce agency, or Department of Labor equivalent, that tells you your unemployment insurance, sometimes known as SUDA, contribution rate for the upcoming year. It’s based on your company’s experience with unemployment claims and other state formulas, and that rate determines how much you’ll pay on each employee’s wages up to the state’s taxable wage base.

Mike Mahoney: How often do employers receive these tax rate notices?

Stephen Kenney: Typically, the notices are sent out once per year, often in late fall for the following calendar year. Some states may have mid-year adjustments or supplemental adjustments, so always check the effective date on the notice when you receive it.

Mike Mahoney: And who is the typical recipient of the notice?

Stephen Kenney: It’s typically sent to the employer of record, which means sometimes that could end up going to your payroll provider, or a third-party administrator if you’ve given them authorization to receive notices on your behalf. It’s important that you make sure your mailing and email contacts with the states are current, so notices don’t go to an old address.

Mike Mahoney: And why exactly is this notice important? Why does it matter?

Stephen Kenney: It directly impacts your labor costs. If you have a one- or two-point swing in either direction, it could mean thousands or millions of dollars in impact depending on your payroll size. It also flags whether your account is being charged for benefits appropriately or if you have excessive benefits for one reason or another.

Mike Mahoney: Now let’s talk about what’s on the notice. What should employers expect to see on the notice?

Stephen Kenney: So, if we picture an unemployment tax rate notice, first you’ll see displayed prominently your account number, the legal entity name. You’ll see the experience rate for the new upcoming year, and then you’ll see the components that are used to derive that experience rate or tax rate, the benefits charges, the taxable payroll, reserve balance or ratio, and any other penalties or surcharges that are going into that calculation. You’ll also see the taxable wage base for the upcoming year. States can change the wage base from year to year.
Any solvency or administrative assessment will be the next thing you see. Sometimes they’ll show your prior rate from a previous year for comparison purposes, and then importantly, you will see a deadline for any appeals or protests and specific instructions on how to execute a protest.

Mike Mahoney: So, you use some terms of art in there that I think I want you to help me define a bit better. What’s a reserve balance or a reserve ratio?

Stephen Kenney: So, the reserve balance is the difference between the taxes you’ve paid in versus the benefits that have been charged to your account. And the reserve ratio is that balance that’s created by taxes that go in, benefits that go out, divided by your average taxable payroll. A higher ratio usually means a lower rate.

Mike Mahoney: Continuing on with a definitions section here, what are benefit charges?

Stephen Kenney: So, when a former employee draws unemployment benefits, they leave your employ, they go file with the state, the state says that they’re entitled to unemployment. The state will then charge all, or part of, those benefits to your employer account, unless the claim is non-chargeable for one reason or another, those charges accumulate, and they feed into your experience rating and tax calculation.

Mike Mahoney: And the taxable wage base, what is that?

Stephen Kenney: So, that’s the maximum amount of each employee’s wages that are subject to unemployment insurance tax for a year. For example, in some states $7,000, other states $9,000. So, once you pay employees more above that threshold, then you no longer have to pay tax on those wages that you pay to employees.

Mike Mahoney: I want to talk about how the rates are calculated. How do states decide the rate that’s applicable to a particular employer?

Stephen Kenney: So, most states use an experience rating model, and typically how they approach this is they start with the taxes paid and the benefits charged over a specific measurement period, then they will calculate the reserve ratio that we spoke about, or a similar metric, and then they’re going to place you into a rate schedule, or bracket, based upon that reserve ratio, and depending upon the overall health of the state’s unemployment insurance fund, they may use a different schedule or different bracket from year to year. And then they’ll apply any adjustments such as if you’re a new employer, you could be eligible for the new employer rate. You could have delinquency penalties for failures to file unemployment insurance tax returns. There could be solvency charges or there could be credits that you’re entitled to that affect the ultimate rate calculation.

Mike Mahoney: One of the adjustments you mentioned was for new employers. Why would new employers have an adjustment, or a specific rate just for them?

Stephen Kenney: So, new employers, the understanding is that they may not have sufficient experience to get a standard rate. So, you can’t really calculate a reserve ratio if you don’t have enough experience paying taxes into the system versus benefits that are being taken out, and so new employers are often assigned a rate that could be based on industry averages, and then once they have enough payroll and time within the system, then there will be a calculated experience rate for them.

Mike Mahoney: Are there other factors that may cause an employer’s rate to go up? Like, what if they habitually, or even occasionally, file late?

Stephen Kenney: Yeah, so if there are late tax filings, many states may impose delinquency rates. So, that could add percentages to your unemployment tax rate if you file late or if you pay late. So, even if you just miss one quarterly report and you never go back and file that quarterly report, you could see a spike in your tax rate up until the point that you actually file that quarterly report.

Mike Mahoney: Let’s pivot a little bit and talk about some common mistakes in how to spot them. What are the most common errors employers should be on the lookout for?

Stephen Kenney: So, I have five big ones that employers should be aware of. So, first is you got to check the payroll base. So, if the state used incorrect taxable wages, or missed a quarter in the calculation of the experience rating, you need to make sure that all the payroll is accounted for.
Second of all is misapplied benefits charges, so benefits charged to you that belong to another employer or non-chargeable, this is the time to review those benefits charges and make sure that they are only benefits charges that should be charged to your specific account. Missing voluntary contributions, so voluntary contributions give you an opportunity to buy down your tax rate, and perhaps you set one in, but it wasn’t applied correctly, so now is your opportunity to make sure that the state has taken that into account. Successor liability errors is the fourth consideration for employers. So, if you acquired a business, or if you’ve sold a business, perhaps there was an impact to your unemployment tax rate based on being deemed a successor, or based on another entity being a successor. So, there should be a movement of that experience based upon the transaction. And then the last is the penalty rate in error. So, perhaps the system has flagged you for missing a quarterly unemployment wage report, but you actually did file that, so now this is your opportunity to go to the state and say, “We did actually file on time. We should not be assessed this penalty rate.”

Mike Mahoney: So, it sounds like there are many common pitfalls for the unwary employer. How should employers verify the accuracy of their rates?

Stephen Kenney: So, it really comes down to a detailed review of the rate notice. And you should take that rate notice, and you should compare it to prior years’ rate notices, not just one year before, but you can go two years back, you can go three years back just to make sure that everything is flowing as expected. And also, employers should look at quarterly wage and tax filings for the computation period. You should be able to add up those quarterly wages and see that reported on the tax rate notice. You should also be able to do the same with benefit charge statements. You should be able to look back for that previous year, see the benefits charges, add them up, and those should be reported properly on the unemployment tax rate notice.
And then lastly is making sure that any acquisition or merger notice documents were submitted to the state. And if you have information about any predecessor unemployment tax rates, you can now take those into account, recalculate your reserve ratio based on any experience you should have inherited from a predecessor and check that against the state’s rate that they are now assigning to you.

Mike Mahoney: You mentioned, I think, a new type of statement in your last response, you mentioned charge statements. Are those different from the rate notices?

Stephen Kenney: Yeah, so a charge statement is really thinking about the individual claims. So, it should be a list of individual claims, and the amounts charged for each individual unemployment claim, and then ultimately what’s charged against your account as the employer based upon that individual claimant’s unemployment benefit. So, you should reconcile them regularly, not just when you’re reviewing your unemployment tax rate notice, and you want to reconcile them regularly so that you can protest them individually within the claim-specific deadlines.

Mike Mahoney: Let’s talk about what employers should do pretty much the moment or the day that the notice arrives. Can you give us, can step-by-step list of what employers should do upon receipt?

Stephen Kenney: So, the moment you get the unemployment tax rate notice in the mail, or if you pull it from an employer portal that you’re set up with for the particular unemployment agency, is you should note the appeal deadline. So, you often only have 15 to 30 days from the notice date to appeal any issue you see with the rate notice, so you really want to note that deadline. You also want to confirm that your legal name, account number, and the effective period of the notice are correct. You then want to go and compare the new rate to last year’s rate. And then fourth, you can reconcile key inputs, those taxable wages, the benefits charges, the reserve balance, just as we previously talked about, you have other data sources that you can pull in to make sure that you can reconcile those taxable wages, benefits and reserve balance against the other data sources. You want to flag any anomalies as a fifth step. So, if you see any sudden jumps in your unemployment tax rate, if you see a surcharge, if you see a penalty rate, you really want to flag that so that you can address within the appeal deadline. Next, you want to make that determination. You want to decide to accept the tax rate, or appeal the tax rate, or the third option is to make a voluntary contribution, if the state allows, where you buy down the rate based on making a one-time contribution to the unemployment insurance fund. Next, you want to update your payroll system’s, unemployment, insurance, tax rate and taxable wage base to be effective 1-1 of the upcoming year. This is important if you’re paying at the wrong rate, you’re going to either be accumulating a tax credit unnecessarily, or if you are paying at the wrong rate and you’re paying less than you should, you’re going to end up paying penalties and interest on top of the amount that you actually do owe based on your current tax rate. And then lastly, you want to reach out to the finance department, make sure that the unemployment insurance taxes are properly budgeted for, and so they can account for the cash flow planning for the upcoming year.

Mike Mahoney: If something looks off on the rate notice, what’s the fastest way to act? What’s the first thing that the employer should really do?

Stephen Kenney: It’s really filing a timely appeal or protest specifically as the notice instructs and online if possible, and then you want to attach any supporting documents, and clearly state the error and the requested correction to make sure that you have the tax rate that you deserve based upon your experience history.

Mike Mahoney: Turning to appeals and protests, when should an employer file an appeal?

Stephen Kenney: They should make sure that they file an appeal within the enumerated timeframe. So, if it’s 15 days, if it’s 20 days, if it’s 30 days, whatever the notice says is really when an employer should be filing an appeal.

Mike Mahoney: And what makes for a strong appeal?

Stephen Kenney: Being specific is key to a strong appeal. So, you want to be able to cite to a specific benefit charge and say, the claimant never worked here. So, you want to say the more specific you can be, the better your chances are that the state is going to accept your appeal.
You also want to have documentation that accompanies your appeal—the wage records, the separation documents, any prior filings or claim determinations—all of those should accompany your appeal and once again, really harping on it. But timeliness states just don’t accept appeals if you miss deadlines. No matter how strong of an argument you have, you need to make sure you meet the deadlines. And then lastly, it’s really just a professional tone and making sure that you request a remedy. If you submit an appeal but the state doesn’t know what you want in response to the appeal, then you may not get anything. So, you need to make sure that at the conclusion of your appeal you are requesting a clear and concise remedy.

Mike Mahoney: You mentioned timeliness, and I know in my experience sometimes clients don’t receive the rate notice quickly, perhaps it gets stuck in their mail room or perhaps it got mailed to an incorrect address. What are employers to do if they miss a deadline?

Stephen Kenney: So, if they miss a deadline, you’re going to be at the mercy of the state to a certain extent. You can make an argument for a late appeal if you can establish good cause. So, if you had a good reason behind it, like you mentioned, Mike, if you receive a tax rate notice late that that could potentially be good cause for filing a late appeal. But if it’s late, there really isn’t any guarantee that your appeal will be processed by the state.

Mike Mahoney: One of the strategies that you mentioned to reduce an employer’s rate was voluntary contributions. What are they, and can you just talk about that for a minute?

Stephen Kenney: So, in some states, and really the majority of states, you can make an optional payment after you receive your unemployment tax rate notice, and you make that payment directly into your account, and that’s going to change the reserve ratio, which in turn lowers your rate. So, it’s essentially you’re buying down your rate in the same way that perhaps you could buy down a mortgage rate by paying additional points at the time that you originate the mortgage.

Mike Mahoney: How does an employer decide if it’s worth it to make a voluntary contribution?

Stephen Kenney: So, there needs to be a cost-benefit analysis that’s conducted at the time you receive your unemployment tax rate notice. So, first of all, you would estimate taxes at your current rate versus what the reduced rate would be if you buy down the unemployment tax rate. And then you’re going to have to project your payroll for the upcoming year, versus payroll with the estimated tax rate and then payroll with the current tax rate, and then you would compare the savings that results from buying down the rate to the contribution amount itself, and balance those two, and then if the savings exceed the contribution, and cash flow allows, then you make the voluntary contribution. But again, you need to watch out for the deadlines here could be 30 to 60 days, depending upon the state, that you need to submit the voluntary contribution, and there are also limits on how far you can buy down a tax rate.

Mike Mahoney: Are there any traps or considerations when an employer’s making voluntary contributions that they may not think of when they undertake that original cost-benefit analysis?

Stephen Kenney: It’s payroll, and whether payroll is going to increase during the year or whether payroll is going to shrink during the year. If payroll changes and you did not account for that while you were projecting the tax rate, then you may not realize the savings that you projected.
And then a voluntary contribution is not refundable typically, so once you make that contribution there really isn’t an opportunity to recoup those funds.

Mike Mahoney: Thanks, Stephen, for all that great detail.

Stephen Kenney: Thanks, Mike. It was really a pleasure having the conversation, and I’m looking to continue the conversation next month.

Mike Mahoney: Thank you all for joining this month’s Payroll Brass Tax. Next month, we’re going to continue the conversation with respect to unemployment insurance rates. We hope you’ll join us then.

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