Unemployment Taxes for Nonprofits

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Nonprofit organizations enjoy special privileges under unemployment laws. What are the privileges, and how can they benefit your organization?  For most nonprofits, the following rules apply: (a) only state law unemployment taxes are owed, not federal; (b) smaller may be better; and (c) self-insurance may provide cost savings (but not always!).  Additional tax considerations apply for covered nonprofits operating in multiple states.  Notably, churches and other religious institutions are entirely exempt from unemployment coverage.

Background:  FUTA, SUTA, and Employee Eligibility

The US system of unemployment taxation and benefits is designed as a cooperative between federal and state programs to promote social welfare.  The Federal Unemployment Tax Act (“FUTA”) imposes taxes equal to a percentage of total wages paid in a year.  All nonprofit public charities are categorically exempt from FUTA.

The state unemployment counterpart is called “SUTA,” which stands for the State Unemployment Tax Act.  Employers that are covered by SUTA generally must contribute into the state government unemployment insurance system so that government funds may be paid out to employee claimants as unemployment benefits.

Generally speaking, an employee is eligible for unemployment benefits if he or she is laid off or terminated without good cause.  Consequently, an employee who resigns is not eligible for unemployment benefits.  Likewise, an employee who is terminated for repeatedly violating a work rule or otherwise engaging in serious misconduct is also not eligible.  A person whose employment is terminated for poor job performance, however, will be eligible for unemployment benefits. 

Church Exemption (What about Severance?)  

Churches, other religious institutions, and church-controlled schools are generally exempt from paying into both the federal and state unemployment system (unless they voluntarily elect to participate in such government system).  In some states like Illinois, such nonprofit organizations are legally required to provide written notice informing employees that they will not be eligible for any unemployment benefits upon termination.

Due to the exemption for these organizations, their leaders should seriously consider offering severance pay when terminating their workers’ employment to provide a substitute “safety net.”  The specific severance amount to be provided is a matter of judicious use of charitable resources, with an eye toward fairness among employees. Such pay should always be accompanied by a written agreement that provides for release of claims by the employee against the employer.  Other severance aspects may be included in the agreement, such as tax treatment, confidentiality, non-disparagement, and return of property.  A severance agreement thus should be drafted with assistance of legal counsel.

Exemption for Nonprofits with Fewer than Four Employees

Except for the religious organizations above, all other nonprofits in Illinois are required to pay state unemployment taxes once if they have at least four employees (whether full-time, part-time, or temporary), during at least 20 weeks of a calendar year.   So if a nonprofit has fewer than four employees, it qualifies for exemption from coverage and is not required to pay into unemployment. 

Three caveats are in order.  First, while this “small potato” exception should be great news to a nonprofit just starting out, its leaders should be prepared to register and pay unemployment taxes as the organization grows.  Second, and on a related note, the term "employee" may be broadly construed for the purposes of state unemployment compensation statutes.  For example, this term may include individuals otherwise regarded by an employer as independent contractors.  Third, as indicated above in relation to churches, written notice may be legally required, with accompanying considerations warranted for employer-paid severance. 

The Self-Insurance Option

An additional privilege available to nonprofits is that they may elect to be self-insured.  This is known as being a “reimbursable employer.”  In other words, the electing nonprofit pays the state only for actual unemployment benefits received by their eligible terminated employees through the government system.  An employer’s liability thus will end when its prior employee becomes reemployed or otherwise becomes disqualified for continued unemployment benefits (e.g., when the eligibility time period ends, which is ordinarily in 13 weeks during periods of low unemployment and 26 weeks during periods of high unemployment, as determined by the government; going to school may also be a disqualifying event).

To become a reimbursable employer, a nonprofit must make such electionprospectively. Likewise, changing back to being an insured employer (i.e, paying contributions as taxes rather than reimbursing the government) must be done in advance.  To make either change, the nonprofit must be current on any and all unemployment taxes owed.  A nonprofit considering reimbursement should thus carefully count the cost by (a) evaluating its work force’s stability and (b) planning well ahead for any major layoff or other significant employee changes that may occur. 

Multi-State Employees and Employer Obligations

What happens if a nonprofit has two employees working at its office in Illinois, one employee working remotely from Seattle, and two employees working remotely from Mississippi?  Is the nonprofit “covered” for unemployment insurance purposes?  Must it pay unemployment taxes into each state system?  Or is the nonprofit completely exempt, since it does not have at least four employees in any one state?  This is an increasingly common employment scenario, so a good understanding is important for effective legal compliance.  Our firm’s next blog article will address this issue in detail.  Stay tuned!