If an organization has employees, it is responsible for several federal, state, and local taxes. As an employer, the organization must withhold certain taxes from employees' pay checks. Employment taxes may include the following: Federal Income Tax Withholding ("FITW"); Social Security and Medicare taxes ("FICA") and Federal Unemployment Taxes ("FUTA").
The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act that pays unemployment compensation to workers who lose their jobs. The program was enacted to encourage states to provide payment to workers who have lost their jobs. FUTA tax should be reported and paid separately from FICA and FITW. FUTA tax is paid only from the organization's own fund. Employees do not pay this tax or have it withheld from their pay. Most employers pay both a federal and state unemployment tax. Every state requires that employers pay a certain tax rate into the pooled unemployment fund, which pays out benefits to workers who lost their job through no fault of their own. Generally an employer pays this tax regardless of whether any of their employees claim unemployment. However, if the employer has a number of claims, the tax rate may increase in subsequent years.
A 501(c)(3) organization is an American tax-exempt nonprofit organization. Section 501(c) of the United States Revenue Code provides that twenty-nine (29) types of nonprofit organizations are exempt from federal income taxes. Non-profit organizations are exempt from federal unemployment taxes but must pay state unemployment tax. In Colorado, 501(c)(3) organizations have a choice of how to pay for unemployment claims: 1) through state unemployment insurance tax or 2) as a reimbursing employer paying the state only for claims paid out to former employees.
Depending on the state, unemployment taxes currently range from point one percent (.1%) to ten point nine six percent (10.96%) on each employee's taxable wages. Although unemployment stabilized in 2004, unemployment taxes still increased in many states because those states must rebuild the unemployment pools. This situation means a nonprofit could be paying much more in taxes than the state is paying out for unemployed nonprofit workers.
Section 3309 of the Federal Unemployment Tax Act enables 501(c)(3) organizations to opt out of the state tax system and reimburse the state only for claims that the state has paid out to the nonprofits' former employees. The national average for nonprofits is $2.20 in taxes for every $1.00 paid in claims, therefore most 501(c)(3)'s will save money by becoming reimbursing employers. However, reimbursing employers are responsible for all the unemployment claims paid to their former employees by the state, no matter the amount. Therefore, the organization could face an unexpectedly large tax bill at the end of the year. The reimbursement option works best for agencies that have stable employment and comparatively low unemployment claims based on the size of the organization.
A third option for non-profits is to join a trust or other third-party reimburser when they leave the state system to add protection and stability to the reimbursement option. The trust option may create a reserve account for claims, help manage and mitigate unwarranted benefits, provide claims court hearing support, and look out of costly state errors.
An employee of a non-profit who is separated from their employment may still apply for unemployment through the regular channels with the Department of Labor. If you are an employee with a question about unemployment, contact an attorney to discuss your legal options.