Are Employers Required To Pay Unemployment Insurance? | The Real Rules Behind The Tax

Yes, most employers must fund unemployment benefits through federal and state payroll taxes once they meet coverage rules for wages paid and worker type.

If you run payroll in the U.S., unemployment insurance is rarely optional. It’s one of those “set it up early” items that saves headaches later, since states can bill back taxes, interest, and penalties when an employer misses registration or reports late.

This article breaks down when you’re required to pay, which tests decide coverage, and the spots where employers get tripped up: household workers, farm labor, nonprofits, and worker classification. You’ll leave with a clean way to decide what applies to your business, plus steps to get compliant without overpaying.

How Unemployment Insurance Is Funded

Unemployment insurance (UI) is funded mainly by employer-paid payroll taxes. In plain terms: employers pay into systems that help workers who lose jobs through no fault of their own.

There are two layers:

• Federal unemployment tax (FUTA) that supports the federal-state UI structure and related administration.
• State unemployment tax (often called SUTA or state UI contributions) that funds most benefit payments in each state.

Most employers end up paying both. The IRS spells out that FUTA is employer-paid and not withheld from employee paychecks, and that most employers pay federal and state unemployment taxes. See IRS Topic No. 759 (Form 940 and FUTA) for the federal coverage tests, plus the filing tie-in to Form 940.

Who Pays: Employer Or Employee

For FUTA, the employer pays. Employees don’t have a FUTA line withheld from wages. The IRS notes that only the employer pays FUTA and it isn’t deducted from the employee’s wages. You can verify that on the IRS page about Federal unemployment tax (FUTA).

State rules vary on whether there’s any employee-side UI withholding in limited cases, but the core UI funding model is employer-paid state contributions, paired with employer-paid FUTA.

When An Employer Is Required To Pay FUTA

Federal rules use tests that depend on the kind of worker you employ. For most businesses, the “general test” is the one that matters.

The General FUTA Test For Most Businesses

Under IRS guidance, you’re generally subject to FUTA and must file Form 940 if you meet wage or employment-time thresholds during the year, based on the IRS’s FUTA coverage tests described in Topic No. 759. The common trigger is paying a minimum amount of wages in a quarter or having at least one employee for a set number of weeks.

If you meet the general test, you’re in FUTA land. That means registering properly, tracking taxable FUTA wages, and filing Form 940 on the annual schedule.

Household Employees Have Their Own Trigger

If you hire household help, FUTA can apply even when you’re not running a “business.” Household rules are tied to cash wages paid in a calendar quarter. IRS instructions for Schedule H note the FUTA trigger for household employees when cash wages hit the threshold in a quarter. See IRS Instructions for Schedule H (household employment taxes).

This catches people with nannies, caregivers, and private household workers. Many families don’t realize unemployment tax can attach once the cash wage threshold is met.

Agricultural Employees Use A Different Test

Farmworkers fall under separate FUTA tests that look at wages paid and headcount/weeks. If you run an agricultural operation, use the farmworker test rather than the general one, since it’s built around agricultural pay patterns.

Are Employers Required To Pay Unemployment Insurance For Every Worker Type?

No. The requirement follows the employee definition and coverage rules. The most common “oops” is treating someone as a contractor while the state sees an employee. That can trigger retro UI assessments, and states can apply it across multiple quarters.

Employees Vs. Independent Contractors

UI taxes are tied to employee wages. Contractors are typically outside UI tax, but the line depends on state law and the facts of the working relationship.

If a worker is directed like an employee, is economically tied to your business like an employee, or lacks real independence, the state may treat them as an employee for UI. That means UI taxes may be due even if you issued a 1099.

Owners, Family Members, And Special Categories

Coverage for owners and family members varies by state and entity type. Some states exclude certain family employment; others include it with conditions. Sole proprietors often aren’t covered for their own UI unless they elect coverage in states that allow it.

If you’re trying to decide whether an owner’s pay is “wages” for UI, check state UI rules for your entity and pay setup, plus whether your state allows elective coverage for owners.

How State Unemployment Tax Requirements Work

States run their own unemployment insurance systems, so the registration triggers, wage bases, and rates differ. The clean rule is this: once you have covered employment in a state, you usually must register with that state’s UI tax agency and pay contributions based on taxable wages.

If you employ people in more than one state, you’ll also deal with “localization of work” rules that decide where wages are reported. That can be simple when a worker lives and works in one state. It gets messy when the worker travels, works remote, or splits time.

To find the correct state UI tax agency contacts and links, the U.S. Department of Labor maintains a directory: Contacts for State UI Tax Information and Assistance.

Rates And Wage Bases Change By State

States set their own wage base (the amount of each employee’s annual wages subject to state UI tax) and assign your rate. New employers typically start with a “new employer” rate, then move to an experience-based rate after enough history builds.

Experience rating means layoffs and benefit charges can raise future tax rates in many states. That’s why clean separation documentation and timely responses to claims matter.

What Nonprofits And Government Employers Must Do

Nonprofits and government entities are often handled differently under state UI rules. Many states allow certain nonprofit organizations to choose a reimbursable method instead of paying quarterly contributions. Under the reimbursable method, the employer repays the UI trust fund for benefits charged, rather than paying a tax rate on wages.

States spell out this choice and the practical tradeoff: contributory payments are steady; reimbursable payments can spike after layoffs. A state example that explains reimbursable employers and the reimbursement approach is on the Washington Employment Security Department site: Reimbursable employers.

Even when reimbursable status applies, you still have registration duties and reporting duties. The “you don’t pay quarterly tax” part doesn’t mean “you do nothing.” It changes the payment method.

What Employers Actually Pay And Why FUTA Often Looks Small

FUTA has a standard rate applied to a federal wage base, with a credit mechanism tied to state UI tax payments. The U.S. Department of Labor’s UI tax material explains the FUTA wage base and the offset credit concept. See the Unemployment Insurance Tax Topic page for the federal wage base and how the credit works.

In practice, many employers see a lower effective FUTA rate when state unemployment taxes are paid on time and the state isn’t in credit-reduction status for the year. That’s why payroll teams pay attention to state UI payment timing even when FUTA filing is annual.

Coverage And Payment Rules At A Glance

The quickest way to stay sane is to sort by employer type, worker type, and where the work happens. Use the table below as a routing map for what to check next.

Employer Situation	Likely UI Obligation	What To Check
Typical business with W-2 employees	State UI contributions + FUTA if federal test is met	IRS FUTA tests; state registration trigger
Startup hiring first employee in one state	Register for state UI; new-employer rate applies	State UI tax agency setup steps
Remote employee working from another state	Likely UI owed to employee’s work state	Localization of work rules; multi-state registration
Household worker (nanny, caregiver) paid cash	FUTA may apply; state household UI rules may apply	Schedule H household FUTA threshold; state household coverage
Agricultural employer with farmworkers	FUTA may apply under farm test; state ag rules vary	Farmworker FUTA test; state agricultural coverage
501(c)(3) nonprofit organization	State UI required; may choose contributory or reimbursable method	State nonprofit election rules; reimbursable terms
Government entity or subdivision	State UI required; often reimbursable structure	State public employer rules and billing method
Using contractors for core work	UI not owed if truly independent; misclassification can create back UI	State worker classification tests and enforcement focus
Business with seasonal spikes and short-term hires	UI owed for covered employees; rates can shift with claims	Seasonal rules; separation documentation; claim response process

Are Employers Required To Pay Unemployment Insurance? The State Side That Trips People Up

Even when federal FUTA is clear, state UI rules can catch you off guard. States can require registration earlier than you expect, and some states apply UI coverage broadly once you have one covered employee.

These are the patterns that cause the most mess:

• Late registration. You ran payroll for months before opening a state UI account.
• Wrong state. A remote worker was reported in the wrong place.
• Wrong worker type. A contractor is treated as an employee by the state UI agency.
• Missed wage detail. Taxable wage base and exclusions weren’t set right in payroll software.

What Happens If You Don’t Pay When Required

States can assess back contributions, apply interest, and add penalties. Some states also assign higher rates after noncompliance. If the issue is worker misclassification, states can assess UI plus related payroll items tied to wage reporting.

On the federal side, failure to file required FUTA returns can create penalties, and missed state UI payments can affect the federal credit calculation for FUTA.

Claims Management Affects Your Future State Rate

When a former employee files for unemployment, the state asks the employer for separation details. Your response impacts whether benefits are charged to your account and how the separation is categorized. A slow response can lead to charges that might have been avoided.

Good habits here are boring, yet they save money: store offer letters, job descriptions, performance notes, attendance records, and separation notices in one place, with dates and clear facts.

How To Set Up Unemployment Insurance Taxes Step By Step

You don’t need a giant finance team. You need a clean sequence and a habit of matching payroll setup to where work is done.

Step 1: Map Where Each Employee Works

Write down each employee’s work state. For remote staff, use where they actually perform services day to day. That state is often where UI contributions will be due.

Step 2: Register With The State UI Tax Agency

Open an employer account in each state where you have covered wages. The DOL directory makes it easier to find the right state office page: state UI tax contacts.

Step 3: Set Up Payroll To Track Taxable Wage Bases

Each state has a wage base for state UI. FUTA has a federal wage base. Your payroll system needs to stop applying UI tax after each wage base is reached, then restart at the start of the new year.

Step 4: File State Reports On The State Schedule

Most states require quarterly wage reports and quarterly UI payments. Due dates and filing methods vary by state.

Step 5: Handle FUTA Filing And Payment

FUTA is reported on Form 940. IRS Topic No. 759 explains who must file and how FUTA ties into the Form 940 filing requirement: Form 940 and FUTA basics.

If you use a payroll provider, confirm that FUTA wages, FUTA credit, and state UI payments are aligned in year-end reporting. Don’t assume the system guessed your state setup correctly.

Quick Checks For Common Employer Scenarios

Use the table below to sanity-check the most common “Do I owe it?” moments. It won’t replace your state’s rules, but it will point you in the right direction fast.

Scenario	Likely Answer	Next Move
First W-2 employee starts next week	UI registration is usually needed right away	Open state employer UI account before first payroll run
Employee moved to another state and kept the same job	UI may shift to the new work state	Check localization rules; register in the new state if needed
Seasonal hires for a short busy period	UI still applies for covered employees	Track separations; respond to claims on time
Household caregiver paid cash	FUTA can apply once the household threshold is met	Review Schedule H FUTA trigger and state household UI rules
All workers treated as contractors	Risk of back UI if misclassified	Match worker facts to state classification tests before scaling
Nonprofit considering reimbursable method	May be allowed; cost can spike after layoffs	Compare contribution vs reimbursement with payroll and staffing plans
Business had no payroll for months, then rehired	UI accounts may stay open; reporting may still be required	Confirm state filing rules for zero-wage quarters
Operating in multiple states with traveling staff	Only one state usually gets UI wages per worker	Document work locations and apply the state’s localization steps

Recordkeeping That Makes UI Audits Less Painful

UI agencies and tax agencies care about wages, where work occurred, and who the worker really was. Keep these items tidy:

• Wage detail by employee and by quarter
• Work location history for remote and traveling workers
• Offer letters and job descriptions
• Time and attendance records where applicable
• Separation documentation and final pay details
• Contractor agreements plus proof of independence when using 1099 workers

If you’re setting up payroll from scratch, build this filing habit early. It’s far easier than recreating facts two years later when someone asks for proof.

Takeaways You Can Act On Today

Most employers are required to pay unemployment insurance taxes once they have covered employees and meet federal or state coverage triggers. The clean path is to register early, align payroll settings to each state wage base, and keep documentation that matches worker classification and work location.

If you want one next step, pick your employees, list where they work, and confirm you’re registered in the correct state UI systems. Then confirm FUTA filing status using the IRS FUTA tests tied to Form 940.