Payroll Brass Tax: Unemployment Tax Rate Season, Part 2—Claims, M&A Activity, and Successor Issues

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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 second part of a two-part segment on unemployment tax rate notices. Joining me again is Stephen Kenney, an associate in Ogletree’s Dallas, Texas office, and a seasoned unemployment insurance and payroll compliance attorney. Stephen, thanks for joining me again.

Stephen Kenney: It’s great to be back. I’m excited to continue the conversation about unemployment tax rate notices.

Mike Mahoney: I want to pivot a little bit. One of the things you mentioned earlier is that M&A activity may also impact rates. Can you discuss how merger and acquisition activity and successor issues impact unemployment insurance rates?

Stephen Kenney: So, if you acquire a business, you may inherit the experience of the business, that being the benefits charges and the reserve balance, and this inheritance can raise or lower your tax rate. States also distinguish between partial and total transfers. Some transfers are mandatory based upon continuity of business tests. Transfers can also be voluntary, so you may have to apply to the state to have the experience transferred. It’s really applying the state unemployment tax rate transfer law to your specific M&A event.

Mike Mahoney: What mistakes may happen in this kind of M&A context?

Stephen Kenney: So, if you don’t notify the state within the required timeline, then they may not be able to transfer the predecessor’s experience to the successor. You could also end up inheriting a high rate unintentionally where the state discovers, or the state has an inkling, that a transaction happens, so they assign you a successor rate, and then you may also fail to request a partial transfer that would’ve reduced your rate. It’s really important to always conduct state unemployment tax rate successor analysis when conducting due diligence during a transaction, particularly when the plan is to have employees move from one EIN, one employer identification number, to being reported under that number to being then reported under another number. So, if you have an asset acquisition, in particular, that can lead to a recalculation of an unemployment tax rate.

Mike Mahoney: I think we’ve largely been talking about for-profit employers. Are there any different rules applying unemployment insurance laws to nonprofits or governmental entities?

Stephen Kenney: Yes, there are. So, many 501(c)(3)s and public employers can elect to be reimbursing employers, which means that they pay dollar for dollar for unemployment benefits instead of a tax rate. So, they don’t receive a rate notice in the same manner, but they do receive charge statements or reimbursement bills. Budgeting claims is critical for 501(c)(3)s since they are reimbursing on a dollar-for-dollar basis.

Mike Mahoney: Are there any special considerations for seasonal or high turnover industries?

Stephen Kenney: So, seasonal or high turnover industries can experience claims on a higher frequency, which can raise rates. So, it’s important for these industries to focus on clean separations, accurate job offers, and prompt unemployment claim responses to reduce chargeable benefits.

Mike Mahoney: And what about multi-state employers? How do they deal with unemployment insurance contributions?

Stephen Kenney: Unemployment tax rate notice season, which is typically Q4, that can be difficult on multi-state employers because each state is going to issue its own rate notice. So that means a multi-state employer is going to have to track and update each state’s rate and wage base. So, they have to pay attention to different appeal windows and voluntary contribution rules, whether mergers and acquisitions were reported in one state but not in another state. So, it really just multiplies the complications for multi-state employers having to deal with multiple states, multiple tax rate notices all within the same season.

Mike Mahoney: Switching gears a little bit, how do state unemployment rates affect federal unemployment taxes or FUTA?

Stephen Kenney: So, unemployment insurance is a jointly run program between the state and federal government. The federal government provides a backstop for the states, and they do that through federal unemployment insurance, also known as FUTA. So normally employers pay FUTA at a 6% rate on the first $7,000 of wages. In other words, a $7,000 wage base. But employers receive a credit of up to 5.4% on that 6% rate if they’re compliant with state unemployment insurance taxes. So, that results in an effective tax rate of 0.6% for federal unemployment insurance. But if a state has a federal unemployment insurance loan balance that it hasn’t repaid, the state may be designated a credit reduction state which reduces the FUTA credit for employers, which effectively increases the FUTA tax rate for employers in that particular state.

Mike Mahoney: Does the rate notice tell you all of that information?

Stephen Kenney: No, not always. So, the Department of Labor publishes the credit reduction states annually. Your year-end FUTA return reflects the higher rate for those states. The state unemployment insurance tax rate notices will not necessarily provide that information.

Mike Mahoney: Let’s change course here a little bit and talk about managing claims to protect employers’ rates. What can employers do to proactively manage their unemployment insurance tax rate?

Stephen Kenney: So, first and foremost, they need to respond to benefit claims promptly and accurately. They need to maintain documentation of separations, warnings, and policies as they establish reason or establish cause for dismissing the employee, so the employee is not eligible for unemployment benefits. They also need to use the side’s e-response system or the equivalent unemployment tax benefit portal that states make available to employers. It speeds up communication with states, makes it easier to respond to unemployment benefit claims notices. Employers should also audit their charge statements monthly or quarterly to ensure that only the charges that are due to them to the dismissal of their employees are applied to their account.
Managers should also be trained on proper separations to avoid chargeable dismissals. And then lastly, an employer should consider contesting claims that don’t meet eligibility standards, but that doesn’t mean that they should fight valid claims, because fighting valid claims is really just a waste of time and energy. They really need to focus on fighting the claims that don’t meet the eligibility standards, which can mean going through a formal hearing process with the state.

Mike Mahoney: Let’s talk about budgeting and payroll setup for a moment. So, once an employer accepts their rate, what do they do next?

Stephen Kenney: So, they should immediately update their state unemployment insurance rate in their payroll system, and that’s on a state-by-state basis and on an employer account-by-employer account basis. So, if you have multiple entities within a state, you need to make sure that you have the correct unemployment insurance rate assigned to each one of those entities within your payroll system. You also need to update the taxable wage base for each state you do business in. Next, you should notify finance of the new cost of payroll based on the unemployment insurance change. And then you should review cash requirements for Q1 since taxable wages reset and unemployment insurance costs are front loaded due to a taxable wage base that is often met in the first or second quarter. So, you got to make sure that the cash is on hand to pay those taxes at the beginning of the new year.

Mike Mahoney: You mentioned that this is typically released in Q4, but are there any mid-year surprises that employers should plan for or be on the lookout for?

Stephen Kenney: So, there can be. You could receive an unemployment tax rate notice in the middle of the year for a few different reasons. So, one is state legislators change the wage base, and that increase could be announced late in the year. There could be a surcharge that’s placed on your unemployment tax rate due to a missed filing. There could be a merger or acquisition that is processed retroactive back to a previous tax year or back to January 1st of the current tax year that you are in. So, it’s important that you keep a little bit of a financial cushion available for unemployment insurance taxes because it could change in the middle of the year.

Mike Mahoney: I want to try something new on the podcast. Let’s do some rapid-fire scenarios. Are you ready for this?

Stephen Kenney: Yeah, let’s do it.

Mike Mahoney: Okay. Your rate jumped from 1.8% to 5.6% seemingly overnight. What are the first three things you should do as an employer?

Stephen Kenney: So first, you should check for a penalty rate. Second, you should reconcile those benefits charges. Then you should confirm your taxable payroll totals. Once you take these three steps, then you should decide either to appeal the tax rate, or you could consider making a voluntary contribution to bring your tax rate back down to something a little more reasonable.

Mike Mahoney: Scenario two, you just acquired another company in July. Your notice includes massive charges. What do you do?

Stephen Kenney: So, you should verify whether a total or partial transfer was processed by the state, and if it should have been processed under the state’s unemployment insurance law, then you accept that new tax rate. If not, if there was no reason to process a transfer here, then you need to appeal and make sure that that experience is not assigned to your account.

Mike Mahoney: In this scenario, let’s assume that you’re a non-profit employer that elected to reimburse, but you still got a rate notice, which was unexpected. What should you do then?

Stephen Kenney: So, you should confirm your status with the state. Sometimes you need to elect to be considered a 501(c)(3) reimbursing employer with the state agency. And if you don’t do that, then they could default to making you a contributing employer instead. But it is also possible that the rate notice is just sent to you for informational purposes or was sent in error. If it assigns a tax rate, so that’s the key component, if you see a tax rate on there and you’re a reimbursing employer, then you contact the state to make sure that you haven’t ended up with a quarterly tax filing requirement.

Mike Mahoney: Let’s say you work for an employer that did not update the rate notice or received the rate notice late, and you overpaid for the upcoming year at a higher, older rate. What should you do then?

Stephen Kenney: So, this is your opportunity to file for a refund or a credit with the state, and you can correct your payroll records, and you can recoup those funds that you paid at the higher rate.

Mike Mahoney: And what should you do if you’re an employer that operates in a FUTA reduction state?

Stephen Kenney: So, you’ve got a budget for this, there’s going to be higher year-end FUTA taxes due, and you need to ensure that you’re timely, your state unemployment insurance payments are also timely to avoid losing any additional credits that you’re eligible for.

Mike Mahoney: Let’s talk about the timeline in the checklist. So, understanding that employers always need to be on their toes and exercise appropriate diligence in looking out for notices, but in an ideal world, this should all flow through a normal progression. Can you give a quick annual checklist for employers?

Stephen Kenney: Yeah. Happy to do so. So, let’s place ourselves first in the Q3, Q4 timeframe, when these notices are sent, notices are soon to be sent out, or already are starting to be sent out. This is when it’s really important to make sure that your address is up to date with the state and that the designated recipient of the notices is the correct person, not the person who left the company two years ago, but the current payroll manager who should be receiving these notices or similar position. Next, you’re going to start receiving those notices. So, upon receipt, you need to calendar the appeal and voluntary contribution deadlines to make sure that you don’t miss them. Now, as we get closer to those deadlines, within a week of those deadlines, you really need to make sure that at this point you have already reconciled the inputs on the tax rate notice and that you’ve escalated any anomalies internally that you need to.

Right before the deadline, you got to make sure you file the appeal or the voluntary contribution with the necessary documentation. Now, as we shift into the new year in early January, that’s when you’ve got to confirm that the payroll rate, the payroll tax rates are up to date, the wage base is up to date, and that you are ready to pay at the new rate that’s been assigned to you and apply the new wage base. Now, if we think about this on a quarterly basis, this is your opportunity in the new year, the end of Q1, end of Q2, end of Q3. This is when you should be auditing your charge statements and responding timely to any claims against your account. And then, if we take a bigger step back year-round, this is when you should be having managers that are put in place that understand how to respond to the benefits notices, how to manage dismissals just so that they don’t become unemployment benefits charges against your account.

Mike Mahoney: Before we close out, I want to talk about some tools and documentation. So, what should employers keep on file?

Stephen Kenney: So, rate notices should remain on file for at least four to six years. Employers should also keep quarterly returns and payment confirmations for the last three years, benefit charge statements and protest decisions for the last three years. Acquisition and merger filings and state determinations, those should remain on file indefinitely. There should be internal reconciliation worksheets and calculations that are kept for the last three years. And then lastly, claims documentations and separation records, which should be kept on file indefinitely.

Mike Mahoney: Are there any tools or technology that you recommend employers use?

Stephen Kenney: So, there should be a shared calendar for the HR team, the payroll team that shows all of the deadlines, include finance and accounting as well. You should be able to create templates for calculations for the reserve ratio, and you could apply that year over year, making minor tweaks as the states make minor tweaks. And if you’re going to, if you’re a large or multi-state employer, you may want to consider a third party to help with unemployment costs management, whether that’s managing benefits claims, or whether that’s managing the large volume of rate notices that you’re going to get at the conclusion of every year.

Mike Mahoney: Before we wrap up, are there any last pieces of advice that you’d like to provide to employers?

Stephen Kenney: Employers should keep in mind that you’ve got to treat the notice like an invoice. You got to review it in detail line by line. And I’ve said it before, but I’ll say it again, don’t miss the deadlines. Most errors on a rate notice can only be fixed if an employer acts timely. I also want to emphasize, do the math, run the numbers on voluntary contributions. This is your opportunity to get a discount, and many employers leave money on the table because they just don’t do the voluntary contribution calculation. And lastly, you’ve got to keep your contact info up to date and current with every state agency. If the rate notice goes to the wrong person or it goes to the wrong address, you’ve missed out on this opportunity entirely, and then you’re going to fall behind, you’re going to pay at the wrong rate, you’re going to incur penalties and interests. This is an important administrative process, and you’ve got to plan for execution of the process every single year. But if you act on these four things, you’re going to be well positioned to handle unemployment tax rate notice season.

Mike Mahoney: That’s a wrap on this month’s Payroll Brass Tax. We hope you join us next month for another interesting installment of issues that we frequently ask questions on. Stephen, thanks for breaking this down so clearly.

Stephen Kenney: My pleasure, Mike. I enjoyed the conversation.

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