Could You Face Credit Reduction Because Of Unemployment Loans?

For 2011, employers in 23 states and the Virgin Islands could suffer a credit reduction on their Federal Unemployment Tax Act tax returns.

Under the provisions of the Federal Unemployment Tax Act (FUTA), a tax is levied on employers covered by the Unemployment Insurance (UI) program. The rate is 6.2 percent on wages up to $7,000 a year paid to a worker.

However, the law provides a credit against federal tax liability of up to 5.4 percent to employers who pay state taxes timely under an approved state unemployment insurance program. Accordingly, in states meeting the specified requirements, employers pay an effective federal tax of 0.8 percent, or a maximum of $56 per covered worker per year.

The credit against the federal tax may be reduced if the state has an outstanding advance - commonly called a loan. When states lack the funds to pay unemployment insurance benefits, they may obtain loans from the federal government. To assure that the states repay these loans, the federal government is entitled to recover those monies by reducing the FUTA credit it gives to employers, which is the equivalent of an overall increase in the FUTA tax.

When a state has an outstanding loan balance on Jan. 1 for two consecutive years and does not repay the full amount of the loan by Nov. 10 of the second year, the federal government will reduce the FUTA credit until the state repays the loan. The reduction schedule is 0.3 percent for the first year and an additional 0.3 percent for each succeeding year until the loan is repaid.

The states in which employers face a credit reduction in 2011 are Alabama, Arkansas, California, Connecticut, Florida, Georgia, Idaho, Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, North Carolina, New Jersey, Nevada, New York, Ohio, Pennsylvania, Rhode Island, South Carolina, Virginia, the Virgin Islands and Wisconsin.

Details on each state are as follows:

  • Alabama and Idaho. Alabama and Idaho repaid their federal Unemployment Insurance (UI) loans by Nov. 10, 2011, and thus are not likely to be subject to the credit reduction.
  • South Carolina. South Carolina has started paying back its federal UI loans and has received conditional approval not to be subject to the credit reduction in 2011. South Carolina was a credit reduction state in the 2010 tax year, so South Carolina employers would be subject to a 0.6 percent credit reduction if the state does not qualify for relief.
  • Michigan. Michigan employers may be subject to a 0.9 percent credit reduction because of the state's failure to repay its outstanding federal loans for four consecutive years.
  • Indiana. Indiana employers may be subject to a 0.6 percent credit reduction because of Indiana"s failure to repay its outstanding federal loans for three consecutive years.
  • Other states and the Virgin Islands. Employers in the other states and the Virgin Islands face a possible 0.3 percent credit reduction on their 2011 FUTA tax returns.

Congressional efforts to eliminate the credit reduction have so far been unsuccessful.

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