Unemployment tax is a payroll tax that employers pay to fund state unemployment insurance programs

Unemployment tax is money that comes out of a business's operating budget, not your paycheck. Your employer sends it to your state's unemployment insurance fund. When you lose a job through no fault of your own, that fund pays you weekly benefits while you look for work. The tax rate and the amount employers pay varies by state and by industry — a construction company in one state pays a different rate than a retail business in another state.

You do not pay unemployment tax directly. Some states have a small employee contribution, but most of the cost falls on employers. The federal government also collects a small unemployment tax (FUTA) from employers to fund administration and to help states during recessions when claims spike.

Key Takeaways

  • Unemployment tax is paid by employers, not deducted from your wages, and funds the weekly benefits you receive if you lose your job.
  • Each state sets its own tax rate, which changes based on how many claims the state has paid out and how much money is in the fund.
  • New businesses pay a standard rate; established businesses pay a rate based on their "experience rating" — how many former employees have filed claims.
  • The federal unemployment tax (FUTA) is a small additional tax employers pay to support state programs and fund administration.

How employers calculate what they owe

Employers calculate unemployment tax by multiplying their payroll by a tax rate set by the state. The rate depends on two things: the state's overall fund balance and the individual employer's history of claims. A business that has laid off many workers pays a higher rate than one with stable employment.

This system is called an experience rating. When you file for unemployment benefits after being laid off, your former employer's account is charged. If many employees file, the employer's rate goes up the following year. If few file, the rate stays low or drops. New businesses usually start at a standard rate and move up or down based on their first few years of claims.

Employers report their payroll and pay unemployment tax quarterly to their state's labor department. The amount is separate from income tax withholding and is not part of your take-home pay calculation.

Why states have different tax rates

Each state runs its own unemployment insurance program and sets its own tax rates. States with higher unemployment or more generous benefit amounts typically charge employers higher rates. States with lower unemployment or smaller benefit amounts charge lower rates. A state might have a range of 0.5% to 5.5% of payroll, while another state's range is 1% to 7%.

States also adjust their rates based on the health of their unemployment trust fund. If a state's fund balance drops too low — usually because claims have been high — the state raises the tax rate on all employers to rebuild it. During recessions, this can happen quickly. After the fund recovers, rates may drop again.

Federal unemployment tax (FUTA)

On top of state unemployment tax, employers also pay a federal unemployment tax called FUTA. The federal rate is 6% of the first $7,000 of each employee's annual wages. However, employers get a credit of up to 5.4% if they pay their state unemployment tax on time, which means the net federal rate is usually 0.6%.

FUTA money goes into a federal account that helps states pay benefits during severe recessions when state funds run low. It also funds the administrative costs of running the unemployment system — processing claims, investigating fraud, and maintaining the computer systems states use to track claims.

Who pays unemployment tax and who does not

Most employers pay unemployment tax if they have employees on payroll. However, some employers are exempt. Agricultural employers with fewer than 10 employees, household employers (people who hire a nanny or housekeeper), and certain religious organizations do not pay unemployment tax in most states. Self-employed people do not pay unemployment tax and generally cannot receive unemployment benefits, though some states have created special programs for self-employed workers.

If you work as an independent contractor, your employer does not pay unemployment tax on your income. This is one reason contractors do not have access to unemployment benefits if the contract ends — there was no unemployment tax paid into the system on their behalf.

What happens to unemployment tax money

Unemployment tax money sits in a state trust fund. When you file for unemployment benefits and are found to be in need, the state pays your weekly benefit amount from this fund. The state also uses the fund to pay for the staff and systems that process claims, investigate fraud, and handle appeals.

If a state's fund runs low, the state can borrow from the federal government. During the 2008 recession and the 2020 pandemic, many states borrowed billions to cover the spike in claims. States then repay these loans by raising the unemployment tax rate on employers over several years. This is why unemployment tax rates can jump suddenly — it usually signals that the state borrowed money and is now collecting it back.

How unemployment tax affects your benefits

Unemployment tax does not directly determine how much you receive in benefits. Your benefit amount is based on your earnings history and your state's formula — usually 50% of your average weekly wage, up to a state maximum. However, unemployment tax indirectly affects you because if the state's fund is low, the state may reduce benefit amounts or shorten the number of weeks you can receive benefits.

Unemployment tax also affects whether benefits are available at all. If a state's fund is depleted and the state cannot borrow from the federal government, the state may stop paying claims until the fund recovers. This has happened in a few states during very severe recessions, though it is rare.

Frequently Asked Questions

Does unemployment tax come out of my paycheck?

No. Unemployment tax is paid by your employer from their business budget. A few states have a small employee contribution, but most of the cost is on the employer. You do not see it deducted from your wages.

Why did my employer's unemployment tax rate go up?

Employers pay a rate based on their experience rating — how many former employees have filed for benefits. If many of your coworkers filed for unemployment after being laid off, your employer's rate rises. Rates also rise when a state's fund is low and the state needs to rebuild it.

Can I get unemployment benefits if I was laid off by a company that did not pay unemployment tax?

It depends on your state's rules. Some states have a fund for workers whose employers did not pay tax or went out of business. Contact your state's unemployment office to ask whether you are covered. If the employer was exempt (like a household employer), you likely cannot receive benefits.

What is the difference between state and federal unemployment tax?

State unemployment tax funds your weekly benefits and state administration. Federal unemployment tax (FUTA) funds a backup account that helps states during recessions and pays for federal administration. Employers pay both, but you only receive benefits from the state fund.

Does self-employment income get unemployment tax?

No. Self-employed people do not pay unemployment tax and cannot receive traditional unemployment benefits. Some states have created programs for self-employed workers, but these are separate from the standard unemployment system and have different rules.