How Severely will COVID-19 Impact SUI Tax Rates?
Reprinted with permission from Equifax Article written b
Unemployment claims anticipated to be filed during this record surge are expected to have a negative impact on SUI tax rates. The question is: when and to what severity?
In this article:
- Impact on 2020 SUI Tax Rates
- Impact of Computation Dates on SUI Tax Rates
- SUI Tax Rating Methodologies
- Solvency of the SUI System
- State SUI Trust Fund Balances
- Federal Title XII Advances
- State Legislative Actions
- Forecasting the Potential Impact to Employers’ SUI Rates
The COVID-19 pandemic has created an unprecedented surge in initial state unemployment insurance (“SUI”) claims. During the nine weeks ending May 16, 2020, there were over 38.5 million initial unemployment claims filed.1 In its May 21st news release, the U.S. Department of Labor reported, “[t]he COVID-19 virus continues to impact the number of initial claims and insured unemployment.” The past nine weeks mark the highest weekly levels of seasonally adjusted initial claims in the history of the seasonally adjusted series. The previous high during any single week was 695,000 in October of 1982.1
Seasonally Adjusted U.S. Weekly Unemployment Claims2
As shown in the above graphic, the Great Recession caused a slow increase in initial unemployment claims. In contrast, there has been a sharp spike in claims due to COVID-19. It’s not just the sharp spike in claims that are concerning, it’s the volume of continued weekly claims. Multiple weeks of unprecedented initial claims have a compounding effect and put stress on the SUI system.
Impact on 2020 SUI Tax Rates
Average U.S. SUI tax rates declined for the past seven years (from 3.48% in 2012 to 1.89% in 20193). The trend is expected to continue into 2020. Any increase in unemployment claims associated with COVID-19 should not have an impact on already established 2020 calendar year rates.
No matter the severity of the COVID-19 pandemic, employers should not experience higher SUI tax costs until January of 2021.
However, there could be an impact on rates in those states that provide for rate changes mid-year or use a fiscal year to determine SUI tax rates. For example, New Hampshire increased employers’ SUI tax rates for Q2 2020. New Hampshire’s rates are assigned annually beginning July 1 of each year. In addition, New Hampshire has a rating provision that requires an adjustment to tax rates quarterly based on state trust fund levels. Due to an increase in unemployment claims in March, the state’s trust fund dipped below $300 million. This resulted in the following 0.5% increase in employer’s UI tax rates.
- For positive rated employers (i.e., those with a positive reserve account balance), there will be a decrease in the “fund balance reduction” from 1.5% to 1.0%, effective April 1, 2020. The minimum rate remains at 0.1%.
- For negative rated employers (i.e., those with a negative reserve account balance), the “inverse rate surcharge” will be applied to employers resulting in a 0.5% increase to rates, effective April 1, 2020.4
Impact of Computation Dates on SUI Tax Rates
For a majority of states, the computation date used to calculate SUI tax rates for the upcoming calendar year is June 30. For these states, the computation date for calendar year 2021 is June 30, 2020. Typically, three or four months does not leave much time for the accumulation of charges to have a material impact on 2021 rates; the impact is likely to be felt more in 2022. However, because of the unprecedented volume of initial claims, the accumulation of benefits could materially impact calendar year 2021 rates
The primary cause for the surge in initial unemployment claims is a reduction in workforce. This causes a reduction in taxable wages used in the calculation of SUI tax rates. An immediate reduction in taxable payroll can exacerbate the negative impact of benefits, depending on the state.
SUI Tax Rating Methodologies
Each state has the legal authority to set the type of experience rating methodology to apply in the formulation of employers’ tax rates. No matter the state in which an employer operates, fiscal year increases in benefit charges will almost always have a negative impact on SUI tax ratings. However, the same cannot be said for decreases in taxable payroll. In the 31 states that use a “reserve ratio” calculation methodology to determine SUI tax rates, sizable decreases in taxable payroll during the rate computation period will likely cause tax rates to decrease (all other factors being equal). In the 19 states that use a “benefit ratio” calculation methodology, sizable decreases in taxable payroll will likely cause tax rates to increase (all other factors being equal).
There historically has been a lag between when economic downturns impact SUI tax rates. This is because rating calculations take into consideration more than just a single year of experience. This can be demonstrated using our most recent recession, which lasted from December 2007 to June 2009.5 In the case of COVID-19, there is little time remaining in the 2021 computation period, assuming a June 30, 2020 computation date, so the lag is expected to be compressed.
Historical Average SUI Tax Rates3
As you can see from the graphic, average SUI tax rates in 2019 were below those experienced at the beginning of the Great Recession and average SUI tax rates in 2020 are expected to be at or below that of 2019. The somewhat good news is that any future increase in rates will be coming off a 15-year low (the average U.S. SUI tax rate in 2002 was 1.80%,3 not shown above).
Solvency of the SUI System
Trust funds are used by state workforce agencies to pay benefits to claimants. The solvencies of these trust funds are assessed based on an index known as the Average High Cost Multiple (“AHCM”), a standard measure of trust fund solvency used by the U.S. Department of Labor. A multiple of 1.00 indicates a state trust fund is deemed sufficiently solvent and able to pay one year of benefits associated with an average recessionary period. Despite improving trust fund balances, 22 states were still not considered adequately funded as of January 1, 2020.6
Average High Cost Multiples as of January 1, 2020
The amount of unemployment benefits expected to be paid out in a relatively short period is not likely to bode well for the system. This may require legislatures and state workforce agencies tasked with ensuring the sufficiency of trust funds to increase SUI tax rates in 2021. The states will have more than six months to observe the severity of the crisis before implementing any such increase to 2021 rating calculations.
State SUI Trust Fund Balances
During Q1 2020, state trust fund balances decreased by $5.13 billion (from $75.68 billion to $70.55 billion).7 It is customary during non-recessionary periods for state trust fund balances to decrease during Q1 of each year. However, the size of this recent decrease is what is concerning. Especially considering the spike in initial unemployment claims did not begin until the week ended March 21, 2020. First quarter trust fund balances over the past three years (Q1 2017 to Q1 2019) only decreased by an average of $2.72 billion.8
Typically we see a replenishment of trust funds in Q2 of each year. This is a direct result of Q1 tax contributions being paid in April. However, this does not appear to be the case in 2020. The claims volume and the fact that a number of states are allowing employers to defer the payment of Q1 2020 tax to later in Q2 and beyond. Equifax has prepared a State Tax Resource Guide summarizing these tax payment deferrals (ManagedPAY is reprinting with permission).
The following graphic compares trust fund balances as of January 1, 2020 to trust fund balances as of March 31, 2020, by state. Initial unemployment claims filed during the nine weeks ended May 16, 2020 have been added. This helps assess the risk of future reductions in state trust fund balances.
Trust Fund Balances and Initial UI Claims7
The depletion of state trust funds can have negative implications not only to future SUI tax rates but also the amount of wages subject to those tax rates. Employers pay SUI tax on wages paid to (or earned by) each employee within a calendar year up to a specified amount, known as the annual taxable wage base. Some states correlate annual taxable wage base adjustments to state trust fund balances.9 Over the past 15 years, taxable wage bases have increased by an average of 2.4% annually. During the height of the Great Recession (from 2008 to 2009 and 2009 to 2010), the average annual increase was 4.8%.
Federal Title XII Advances
The governor of any state may request a loan under Title XII of the Social Security Act. This is typically done when a state’s reserves are inadequate to pay anticipated future unemployment benefits. If a state has an outstanding loan balance on January 1 of two consecutive years and has not repaid the balance by November 10 of that second year, employers in the state are at risk of losing a portion of their FUTA tax credit for that year. The FUTA tax credit starts at 5.40% and is reduced by 0.30% (known as the FUTA credit reduction) for each year the loan remains outstanding beyond the second year. The FUTA tax rate is a net 0.60% because of the FUTA tax credit [6.00% (gross FUTA tax rate) – 5.40% (FUTA tax credit) = 0.60%)].10
In the first year of the FUTA tax credit loss, the net FUTA tax rate increases from 0.60% to 0.90%. The net FUTA tax rate can increase further, in increments of 0.30% per year, if the loan remains outstanding in subsequent years.
During April and May, California borrowed a total of $1.428 billion from the federal government and has since repaid the advances with revenue from Q1 2020 tax contributions. As of May 21, 2020, the following states have received Title XII advances or have been granted authorization for future advances (like a line of credit).
Title XII Advance Activities Schedule7
* Federal Title XII advance existed prior to COVID-19 crisis and continues to be subject to FUTA credit reductions.
Employers in states that accept advances during calendar year 2020 should not be subject to FUTA credit reductions until 2022. The first January 1 will occur on January 1, 2021. The second January 1 will occur on January 1, 2022. Should a state’s Title XII advances remain outstanding on November 10, 2022, employers in the state will be subject to a 0.30% increase in the FUTA tax rate, from 0.60% to 0.90%, for the entire 2022 calendar year.
Coronavirus Aid, Relief, and Economic Security Act
On March 27, 2020, Congress approved and the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The unemployment insurance provisions include:
- An additional $600 per week payment up to four months (through July 31), above and beyond other unemployment benefits a claimant might receive;
- Extension of benefits to self-employed workers, independent contractors and those with limited work history;
- Temporary full funding of the first week of regular unemployment benefits for states with no waiting period (this provision provides incentive for states to suspend their first week waiting period); and
- Extension of unemployment benefits for an additional 13 weeks through December 31, 2020 after state unemployment benefits end (typically after 26 weeks).
Any additional or supplemented federally funded unemployment benefits should not have an impact on employers’ SUI tax accounts or SUI tax rates.
The CARES Act also contains provisions for reimbursing employers (i.e., non-profits that elect to directly “reimburse” benefits versus paying tax). One provision relieves reimbursers of 50% of unemployment benefits through December 31, 2020. This non-charging of benefits relates to all benefits, not just those related to COVID-19 claims. Nevertheless, per the UIPL No. 18-20, state workforce agencies will invoice reimbursing employers for 100% of charges incurred. To be eligible to recoup 50% of the charges, employers must pay their invoice in full. Several states have elected to provide relief of 100% of charges, versus 50% under the CARES Act.
Deferral of Employer Share of Social Security Tax Payments
In addition, the CARES Act expands payroll tax relief to Social Security tax payments; employers of any size may defer the payment of their share of 2020 Social Security tax payments. Fifty percent (50%) of the payments that would have been required between the date of enactment of the CARES Act and December 31, 2020 can be deferred until December 31, 2021. Employers can defer the remaining 50% until December 31, 2022.
There is no “election” required, employers just need to “short pay” the deposit amount. The IRS has released a draft of Form 941, Employer’s Quarterly Federal Tax Return, that includes information for reporting Social Security tax deferrals. Per the preamble to the current version of Form 941, “[i]f you paid any qualified wages between March 13, 2020, and March 31, 2020, inclusive, you will include 50% of those wages together with 50% of any qualified wages paid during the second quarter of 2020 on your second quarter Form 941… to claim the employee retention credit. Do not include the credit on your first quarter Form 941…”
State Legislative Actions
Most states have taken actions in response to the COVID-19 crisis. Some of these actions relate to benefit eligibility and some to SUI tax rates.
Non-Charging of Benefits
The most meaningful of these actions to date is the “non-charging of benefits.” For example, Iowa Workforce Development (“IWD”) has provided the following: “IWD is not charging employers for claims made by their employees due to Covid 19 related unemployment. We have established a trigger for the balance of the Unemployment Insurance Trust Fund at which point, it will be necessary to begin to charge employers accounts for respective unemployment claims. We have established the trigger at $950M and the trust fund balance is currently at $1.10B or $180 million dollars over that trigger of $950 million.”11
So far, the following 34 states have some type of “non-charging of benefit” provision:
States with Non-Charging of Benefit Provisions
The benefits not charged to specific employers will be “socialized” and come out of state trust funds. Any sizable depletion of funds will likely have a negative impact on all employer tax rates in a state; not just those with significant reductions in workforce. It is more important than ever for employers to audit benefit charge statements to help ensure that benefits that should not be charged, are not charged. Equifax has prepared a State Claims Resource Guide summarizing certain COVID-19 related claims information, including states with “non-charging of benefit” provisions.
Deferral of Quarterly Unemployment Tax Payments
As with the CARES Act, many states are deferring the payment of state payroll-related taxes. This includes unemployment quarterly contributions reports. For example, the California Employment Development Department (EDD) announced that: “[e]mployers statewide directly affected by the new coronavirus (COVID-19) may request up to a 60-day extension of time from the EDD to file their state payroll reports and/or deposit payroll taxes without penalty or interest. This extension may be granted under Section 1111.5 of the California Unemployment Insurance Code (CUIC). A written request for extension must be received within 60 days from the original delinquent date of the payment or return.”
Other State Actions
On May 4, 2020, the North Carolina General Assembly ratified and the Governor signed into law Senate Bill 704, “an Act to provide aid to North Carolinians in response to the Coronavirus disease 2019 (COVID-19) crisis.”
The Act provides that “[a]n employer is allowed a tax credit for a contribution to the Unemployment Insurance Fund… for contributions due for the calendar year 2020. The amount of the credit is equal to the amount of contributions payable on the report filed by the employer on or before April 30, 2020. If an employer remitted the contributions payable with the report due on or before April 30, 2020, the credit will be applied to the contributions payable on the report due on or before July 31, 2020. An employer must file the report to receive the credit. If the amount of the credit exceeds the amount of contributions due on the report, the excess credit amount is considered an overpayment and will be refunded…”
Another example of states taking action to mitigate potentially higher future unemployment tax rates for employers as a result of COVID-19, Indiana passed HB 1111 providing a new tax rate schedule (Schedule C) that is to remain in effect through 2025.
Forecasting the Potential Impact to Employers’ SUI Rates
In order to help identify the risks associated with increased SUI tax costs in 2021, it would be beneficial for employers to prepare SUI tax rate forecasts for accounts that have significant taxable payrolls. Employers will have to make certain estimates and assumptions to help generate an accurate forecast, including:
- Number of claims filed or expected to be filed
- Benefit charges since the last computation date and expected through the next computation date
- Benefits that will not be charged to employers
- Taxable payroll since the last computation date and expected through the next computation date
- Tax contributions paid since the last computation date and expected through the next computation date
We recommend that employers prepare forecasts after the computation date (June 30, 2020 in most cases). Employers will have more accurate estimates and assumptions, producing more accurate forecasts.
How quickly will the increase in SUI tax costs reach employers? Will the costs slowly ramp up as with recessions of the past? Furthermore, will the costs surge as quickly as the filing of initial unemployment claims?
In summary, federal and state legislatures are in the process of reacting to this crisis. In fact, some of the provisions enacted to date attempt to make it easier for claimants to obtain benefits. However, this could negatively impact SUI tax rates. Alternatively, other provisions attempt to mitigate some of the financial hardship expected on employers in 2021 and beyond.
Keep in mind, some of the potential increase in SUI tax costs could be felt in 2021 and some thereafter. For computation dates that are after June 30 (e.g., September 30 or December 31), 2021 SUI tax rates may be impacted even more severely. Since the unemployment system is based on an insurance concept, employers will ultimately bear the financial burden associated with COVID-19.
To keep up-to-date, please visit our COVID-19 Resources page which will be updated as new information becomes available. Or, reach out to your Equifax unemployment representative to help address potential SUI tax rate impacts from COVID-19. Not a current client? Please feel free to contact our Employment Tax Consulting Group with any questions.
Disclaimer: The information provided herein is subject to change. It is intended as general guidance and not intended to convey specific tax or legal advice. Before taking any actions, employers should consult with internal and/or external counsel.
1 Per U.S. Department of Labor Unemployment Insurance Weekly Claims News Releases issued from March 26th to May 21st, 2020. The amount reported for the week ended May 16th represents the advance figures for seasonally adjusted initial claims. 2 Per U.S. Department of Labor, Office of Unemployment Insurance Weekly Claims Data. 3 Per Average Employer Contribution Rates by State issued by the U.S. Department of Labor, Employment & Training Administration. 4 Per New Hampshire Employment Security website. 5 Recessionary period according to the Federal Reserve. 6 Per 2020 SUI Trust Fund Solvency Report issued by the U.S. Department of Labor, Office of Unemployment Insurance, Division of Fiscal and Actuarial Services (February 2020). 7 Per data obtained from the TreasuryDirect “Unemployment Trust Fund Report Selection” site (a service offered by the U.S. Department of the Treasury Bureau of the Fiscal Service). 8 Per respective Unemployment Insurance Data Summary reports published by the U.S. Department of Labor. 9 Per Comparison of State Unemployment Insurance Laws 2019 issued by the U.S. Department of Labor, Employment and Training Administration. 10 Per IRC Section 3302 and related U.S. Treasury Regulations. 11 Per Iowa Workforce Development COVID-19 Information Page.