The Hidden Costs of Downsizing
In today’s economy, businesses large and small are faced with the increasingly difficult goal of staying profitable.
To avoid operating in the red, many employers are downsizing their current operations. This trend has been monitored closely by the U.S. Department of Labor’s Bureau of Labor Statistics (BLS), which recently reported that April nonfarm payroll employment continues to decline and the unemployment rate rose from 8.5 to 8.9. Since the recession began in December 2007, 5.7 million jobs have been lost. With many corporations making headlines with recent announcements of pending job cuts, it is unlikely that we have seen the end of these cutbacks.
The major objective of any downsizing is to reduce costs (e.g., reduction of payroll, streamlining functions, etc.). Whether this strategy involves the closing of a single plant, eliminating an unprofitable division, or laying off employees across the board, careful planning is necessary to minimize employment tax costs or to understand what the additional cost of a downsizing may be. Often overlooked in the downsizing process is the impact labor reduction has on state unemployment taxes and benefit costs. Because the employment tax function usually is separate from the tax and finance functions (and may even rest with an outside vendor), these issues often are never addressed during downsizing.
Unemployment Tax Consideration
The yearly State Unemployment Insurance (SUI) tax rate assigned to a company in each state is based on the organization’s unemployment experience. Typically, “experience” is comprised of the organization’s history of unemployment claims filed by former employees and taxes or taxable payrolls over a period of three years. Therefore, as layoffs increase, so do the number of individuals who will collect unemployment benefits. As claims increase, the SUI tax rate increases. Conversely, when claims are low in comparison to SUI taxes paid, the rate is reduced. The range between the highest and the lowest rate in any given state can be substantial. For example, the 2009 calendar year minimum SUI tax rate in Illinois of 0.6 applied against the taxable wage limit of $12,300 results in an unemployment tax of $73.80 per employee. At the maximum, a tax rate of 6.8 applied to the $12,300 wage limit escalates the tax to $836.40 per employee. Considering that the SUI rate may remain high for years, employers should budget for this increase and examine the ways in which they can control these increases.
Rate Control
Review of unemployment tax rate calculations, benefit charges, and unemployment claims is important following a layoff. Often employers accept as proper all claims and charges without any substantive review because they assume that the claimants are entitled to benefits or the state is overseeing the payment of benefits and has made a substantive determination on the appropriateness of the claims. In addition, some companies have a human resources policy to accept all reduction in force claims as appropriate without protest. Such complacence may cause the employer to lose its right to protest various types of disqualified income such as severance or vacation pay that will result in unnecessary and costly charges. It is therefore important to monitor unemployment tax rates and to evaluate any available voluntary buy downs or joint account opportunities. State agencies make mistakes and those mistakes may affect your unemployment tax rate. If these errors are not addressed in a timely manner and if available elections are not made within the timeframe allowed by the states, the employer may suffer an employment tax rate increase that could have been avoided with a timely response.
Reimbursable Account Option
Certain nonprofit employers may choose the reimbursement method of paying unemployment benefits. Employers who choose the reimbursement method reimburse the full amount of unemployment benefits paid to former employees based on wages earned while in their employ. No quarterly unemployment insurance tax is paid. Notices are mailed quarterly to reimbursing employers listing benefits paid and amounts owed. The election to become a reimbursing employer is generally made annually. It is important for nonprofit employers to understand what method they use to pay unemployment and to consider downsizing plans when making future elections.
Bottom Line
In the current environment where cost minimization is a priority, it is important to ensure that downsizing activities do not unnecessarily increase unemployment tax expense. With the appropriate unemployment tax control strategies, cost minimization objectives can be met.
