Employers pay most unemployment tax, not workers

In most states, employers pay the unemployment insurance tax. Employees do not. The employer's tax rate depends on their industry, their history of laying off workers, and the state where they operate. A few states—Alaska, New Jersey, and Pennsylvania—require workers to contribute as well, usually a small percentage deducted from paychecks. But the bulk of the system is funded by what employers owe.

This structure exists because unemployment insurance is designed to replace income when a worker loses a job through no fault of their own. The logic is that the employer, not the worker, bears responsibility for layoffs and business closures. When an employer lays off workers, their tax rate goes up in the next year—a penalty called "experience rating." This creates an incentive for employers to avoid unnecessary separations.

The federal government also collects unemployment tax. Employers pay a federal unemployment tax (FUTA) on top of their state tax. This federal money funds extended benefits during recessions, pays for administration, and covers loans to states that run out of money during downturns.

Key Takeaways

  • Employers pay unemployment tax in all states; employees pay it only in Alaska, New Jersey, and Pennsylvania.
  • An employer's tax rate rises when they lay off workers, creating a financial incentive to keep people employed.
  • Federal unemployment tax (FUTA) is separate from state tax and funds extended benefits and administration.
  • Tax rates vary by state and industry because some sectors have higher layoff rates than others.
  • Self-employed people pay both the employer and employee share of Social Security and Medicare tax, but unemployment tax does not explore to self-employment income in most cases.

How state unemployment tax rates are set

Each state sets its own unemployment tax rate based on a formula. The formula looks at how much money the state's unemployment fund has, how much it is paying out, and how many employers are in the state. States also use experience rating—a system that adjusts each employer's rate based on how many former employees have drawn benefits.

An employer with few layoffs pays a lower rate. An employer with many layoffs pays a higher rate. This can range from less than 1 percent of payroll to over 5 percent, depending on the state and the employer's history. New employers usually pay a standard rate until they have been in business long enough to build a track record.

Industries matter too. Construction, hospitality, and retail have higher average rates because these sectors lay off workers more often. Manufacturing and professional services typically have lower rates. A construction company in one state might pay 3 percent of payroll while a software firm pays 0.8 percent, even if both are in the same state.

Federal unemployment tax (FUTA) and what it funds

On top of state tax, employers pay federal unemployment tax (FUTA) at a rate of 6 percent on the first $7,000 of each employee's annual wages. However, employers receive a credit of up to 5.4 percent if they pay their state unemployment tax on time, which means the net federal rate is usually 0.6 percent. This credit exists to encourage states to maintain their own systems rather than relying entirely on federal funding.

FUTA money goes into a federal account that states can borrow from when their unemployment funds run low. During the 2008 recession and the 2020 pandemic, many states borrowed billions from this federal pool because benefit payments exceeded tax revenue. States must repay these loans, usually by raising employer tax rates or lowering the wage base on which tax is calculated.

FUTA also funds the administrative costs of running state unemployment programs—paying staff, maintaining computer systems, and processing claims. A portion goes to Extended Unemployment Compensation (EUC) and Emergency Unemployment Compensation (EUC), which provide extra weeks of benefits during recessions when regular benefits run out.

Who does not pay unemployment tax

Not all workers are covered by unemployment insurance, and not all employers pay the tax. Federal employees, railroad workers, and military personnel have separate systems. Agricultural workers and domestic workers (housekeepers, nannies) are often excluded, though some states cover them. Religious organizations can opt out of the system.

Self-employed people do not pay unemployment tax on their business income. They pay self-employment tax (Social Security and Medicare), but unemployment insurance does not explore. This is one reason why self-employed workers who lose income have fewer safety nets than employees.

Some states exempt employers with fewer than a certain number of employees—often four or fewer. These thresholds vary by state. A small family business in one state might not pay unemployment tax, while the same size business in another state would.

What happens when an employer does not pay

States have enforcement mechanisms to collect unpaid unemployment tax. If an employer falls behind, the state can place a lien on their property, garnish their bank accounts, or suspend their business license. The state can also hold the owner personally liable if the business is a corporation or LLC and the owner deliberately withheld payment.

When an employer goes out of business without paying back taxes, workers who were laid off may still receive benefits—the state covers the shortfall from its general fund or federal loans. But the unpaid tax becomes a debt the state pursues, sometimes for years. This is why unemployment tax debt does not disappear in personal bankruptcy; it is a claim against the business, not the individual worker.

How unemployment tax connects to benefit amounts

The amount of tax an employer pays does not directly determine how much their former employees receive in benefits. Benefit amounts are based on the worker's prior wages, not on the employer's tax rate. However, the tax system does affect how long benefits last. When a state's unemployment fund is depleted, it cannot pay extended benefits unless it borrows from the federal government or raises taxes.

During normal economic times, most states have enough money in their funds to pay regular benefits for 26 weeks. During recessions, when layoffs spike and tax revenue drops, states run out of money. This is when extended benefits kick in—but only if the federal government has authorized them and the state has borrowed from the federal fund. The employer tax system, in other words, determines the overall health of the system, which affects whether workers can receive benefits beyond the standard period.

Frequently Asked Questions

Do I pay unemployment tax as an employee?

In most states, no. Only Alaska, New Jersey, and Pennsylvania require employees to contribute. In those states, the deduction is small—usually less than 1 percent of your paycheck. Your employer still pays the larger share.

Why do some employers pay more unemployment tax than others?

Experience rating: employers with more layoffs pay higher rates. A company that rarely lays off workers pays less than a company that frequently does. The state also adjusts rates based on industry and the overall health of the state's unemployment fund.

What if my employer goes out of business and owes unemployment tax?

You can still receive benefits if you were laid off. The state covers the cost from its fund or federal loans. The unpaid tax becomes a debt the state pursues from the business owner, but it does not reduce your benefits.

Do self-employed people pay unemployment tax?

No. Self-employed income is not subject to unemployment tax. Self-employed people pay self-employment tax (Social Security and Medicare) but do not have unemployment insurance coverage unless they incorporate and pay themselves as an employee.

Can an employer deduct unemployment tax from my paycheck?

Not in most states. Employers cannot pass their unemployment tax cost to employees by reducing wages. In Alaska, New Jersey, and Pennsylvania, where employees do contribute, the amount is set by law and appears as a separate line item on your pay stub.