Unemployment tax is money your employer pays into a government fund that supports workers who lose their jobs
Unemployment tax is not taken from your paycheck. Instead, your employer pays a percentage of your wages to either your state or the federal government — or both — to fund unemployment insurance programs. When you lose your job through no fault of your own, you can draw from this fund while you search for work. The tax rate and the wage base (the maximum salary amount subject to tax) vary by state and change year to year.
The system has two main parts: state unemployment insurance, which every state runs, and federal unemployment tax, which funds administration and extended benefits during recessions. Most workers never see this tax on their pay stub because it comes out of the employer's pocket, not yours. But it directly affects how much money is available if you file for unemployment later.
Key Takeaways
- Unemployment tax is paid by employers, not deducted from your wages, and funds the state and federal unemployment insurance systems.
- State unemployment tax rates vary by state and by industry, ranging from roughly 0.5% to 5.4% of employee wages, depending on the employer's history of layoffs.
- Federal unemployment tax (FUTA) is a flat 6% on the first $7,000 of each employee's annual wages, though employers can claim a credit for state taxes paid.
- The amount of unemployment tax paid does not determine how much you receive if you file for unemployment — that depends on your state's formula and your prior earnings.
How state unemployment tax works
Each state runs its own unemployment insurance program and sets its own tax rate on employers. The rate is not flat — it depends on the employer's experience rating, which is a record of how many former employees have filed for unemployment. An employer with few layoffs pays a lower rate; one with many pays a higher rate. This creates an incentive for employers to avoid unnecessary terminations.
The wage base — the maximum salary amount subject to tax per employee per year — also varies by state. In some states it is $7,000 per year; in others it is $40,000 or higher. Once an employee's wages reach that cap in a calendar year, the employer stops paying state unemployment tax on that worker's additional earnings. The state publishes its rates and wage bases each year, usually in October or November for the coming year.
States use the money they collect to pay unemployment benefits to workers who file claims. If a state's fund runs low, it may raise tax rates on employers or borrow from the federal government. During the 2020 pandemic, many states borrowed heavily and then raised rates to repay those loans.
How federal unemployment tax (FUTA) works
Federal unemployment tax, or FUTA, is a flat 6% tax on the first $7,000 of each employee's wages per calendar year. This is a federal tax that applies to all employers, regardless of state. However, employers can claim a credit of up to 5.4% for state unemployment taxes they actually paid, which means the net federal tax is often only 0.6% after the credit.
The federal government uses FUTA revenue to fund the administration of state unemployment programs and to pay for extended unemployment benefits during recessions. When unemployment is very high, the federal government may extend the number of weeks a person can collect benefits beyond what the state normally allows, and FUTA helps pay for that.
Unlike state tax, FUTA has a fixed wage base of $7,000 per employee per year. Once an employee earns $7,000 in a calendar year, the employer stops paying federal unemployment tax on that worker's additional earnings for that year.
Why the tax rate varies by employer
State unemployment tax rates are not the same for every business. States use an experience rating system that rewards employers with stable workforces and penalizes those with high turnover. An employer that rarely lays off workers pays a lower rate — sometimes as low as 0.5% — while an employer with frequent separations might pay 5.4% or higher.
New employers often pay a standard rate until they have been in business long enough to build an experience rating, usually three to five years. Some states also adjust rates based on industry. Construction and hospitality, which have seasonal layoffs, may have higher baseline rates than other industries.
This system is designed to make employers think twice before laying off workers, since doing so directly raises their tax bill. However, the experience rating does not explore to workers who quit, are fired for misconduct, or are laid off due to lack of work — only to workers who are separated for reasons the state considers beyond the employer's control.
The difference between unemployment tax and unemployment benefits
Unemployment tax and unemployment benefits are related but separate. The tax is what employers pay into the system; the benefit is what workers receive from it. The amount of tax an employer pays does not determine how much a worker receives in benefits. Instead, benefits are calculated using a formula based on the worker's prior earnings and the state's benefit structure.
Most states replace roughly 50% of a worker's prior wages, up to a maximum weekly amount that varies by state. A worker who earned $2,000 per month might receive $400 to $500 per week in benefits, depending on the state. The duration of benefits also varies — most states offer 26 weeks of regular benefits, though some offer fewer and some offer more.
If a worker is denied benefits because they quit or were fired for misconduct, the employer's tax rate may not change, because the employer did not cause the separation. Conversely, if many workers file for benefits after a layoff, the employer's experience rating goes up and their tax rate rises, even if the workers receive only a small amount in benefits.
What happens to unemployment tax during a recession
During a recession, unemployment rises sharply, which means more workers file for benefits and states pay out more money. At the same time, employers may be laying off workers, which raises their experience ratings and increases their tax bills. This creates a difficult situation: employers are struggling financially while their unemployment taxes are rising.
Many states do not have enough money in their unemployment trust funds to pay all the benefits owed during a severe recession. When that happens, they borrow from the federal government. After the recession ends, states must repay those loans, usually by raising employer tax rates. This is what happened in 2009 after the financial crisis and again in 2020 during the pandemic.
The federal government can also extend unemployment benefits beyond the normal duration during a recession. These extended benefits are funded by FUTA, which is why the federal unemployment tax exists even though states run their own programs.
Frequently Asked Questions
Does unemployment tax come out of my paycheck?
No. Unemployment tax is paid entirely by your employer and does not appear on your pay stub. It is a separate business expense. You may see other taxes on your paycheck — income tax, Social Security, Medicare — but unemployment tax is not one of them.
Can I deduct unemployment tax on my personal tax return?
No. Unemployment tax is an employer expense, not a personal one. If you are self-employed, you do not pay unemployment tax at all. Only employers pay it. If you receive unemployment benefits, those benefits are taxable income and must be reported on your tax return.
Does a higher unemployment tax rate mean I will get more benefits?
No. The unemployment tax rate your employer pays has no effect on the amount of benefits you receive. Benefits are calculated based on your prior wages and your state's benefit formula. An employer with a high tax rate straightforward means they have had many layoffs in the past, not that their workers receive larger checks.
What if my employer does not pay unemployment tax?
Employers are required by law to pay unemployment tax. If an employer fails to pay, the state can impose penalties and the employer may owe back taxes plus interest. Workers are still may have access to to file for unemployment benefits even if their employer did not pay the tax — the state will pursue the employer for the unpaid amount.
Does unemployment tax explore to all workers?
Most workers are covered, but there are exceptions. Some states exclude agricultural workers, domestic workers, and workers at nonprofits or government agencies, depending on the number of employees. Self-employed people do not pay unemployment tax. Check your state's rules if you are unsure whether your job is covered.