Additional Payroll Taxes

By Jason Watson, CPA
Posted Sunday, December 29, 2024

The IRS will expect unemployment taxes (FUTA) on all W-2 wages paid, including corporate officers. According to IRS Topic Number 759, for the 2025 tax year the first $7,000 will be taxed at 6% with a credit of up to 5.4% for unemployment taxes paid to your state (SUTA). This $7,000 has not changed since 1983. Crazy!

Some states such as Alaska, Kansas, Minnesota, Nebraska, Oregon, Washington state and Washington D.C. will allow you to opt out of state unemployment.

Before you opt out of your state unemployment taxes, consider two things. First, you get a credit for the state unemployment taxes paid when you file your federal unemployment taxes on Form 940. This is a big deal. Here is how it works-

Minnesota (for example) has a wage base of $40,000 (for the 2023 tax year). Let’s say the average SUTA rate is 2.6% and your salary is $42,000. You would pay $910 to Minnesota for unemployment. Then, because you paid into Minnesota’s unemployment system, the IRS only charges you 0.6% of the first $7,000 or $42. So… $910 + $42 = $952. If you opted out, you would only pay 6% of the first $7,000 or $420. Opting out in Minnesota at this wage base makes sense.

In Colorado, where you cannot opt-out but provides a good illustration, the wage base is $20,400 (for the 2023 tax year). If your SUTA rate was 2.1% then you would pay $428 to Colorado and $42 to the IRS for a total of $470. If you could opt out and did opt out, the IRS would charge you 6% of the first $7,000 or $420. A tiny savings, but a savings nonetheless (you just covered 10% of your wine pairing dinner at Ski Tip Lodge in Keystone).

Some states, such as California, were in arrears with the federal government on unemployment debt payments and as such the credit the IRS provides was reduced. For example, the FUTA rate is 0.6% if you pay SUTA, but for California businesses the FUTA rate is 2.7% in addition to the SUTA rate. California caught up on its federal unemployment debt in 2018 thanks to the backs of resident taxpayers, and the FUTA rate will revert to 0.6%.

Note the subtle difference- full FUTA rate is 6% and the reduced rate is 0.6%. The simple decimal move is sneaky.

The COVID unemployment craziness will certainly put more states into arrears with the federal government. It will be interesting to see how this plays out. There could be debt payments made on the backs of small businesses as they see a higher unemployment tax. Remember, unemployment is a payroll tax that is wholly paid by the employer.

Second… and this one you might laugh at… second, if you shut down your S corporation you might be eligible for unemployment benefits. Remember, unemployment benefits are administered by the state and if you opt out because of your corporate officer exemption, you could be limiting yourself unintentionally. Yeah, this is crazy but beware just the same.

Pre-COVID and from direct experience with some of our clients, Colorado fights the heck out of a former business owner collecting unemployment benefits; the business owner must show that his or her business suffered a catastrophic event; one that prevented future business income. Many other states are similar. During 2020 and 2021, all kinds of nutty things were happening with small business owners and unemployment benefits being paid to them. It’ll take some time to unravel and settle back into a predictable future.

COVID also shined a light on sick pay and disability, including medical leaves. Therefore, many states recently passed legislation to fund various state-ran programs to address these issues.

For example, California, Hawaii, New Jersey, New York and Rhode Island impose a state disability insurance (SDI) payroll tax when you run payroll on the shareholders (as of 2022). Colorado has the FAMLI program which stands for Family and Medical Leave Insurance. As of October 2023, over 20 states have some sort of paid family leave.

Critical Note: Specifically, California charges 0.9% with a maximum of $1,378 (0.9% x $153,164). Starting in 2024, however, California’s SB 951 eliminated the wage limit but lowered the tax to 0.9%. Yuck.

You can opt-out of California’s SDI if your underlying entity is a corporation or if you obtain voluntary disability insurance from an approved insurance provider. Read that again. This is for corporations. An LLC taxed as an S Corp remains an LLC with the Secretary of State and as such cannot opt-out of SDI. A C or professional corporation taxed as an S Corp may. Subtle difference, but one that bites people all the time.

But there is an interesting situation with California (and perhaps other SDI states). In California, employees pay into the insurance fund and not the employer. So, if you were paid a W-2 salary of $100,000 and then was converted to a 1099 contractor, you are suddenly saving $1,000 in state disability insurance taxes. Then again, if you create a corporation and also elect S Corp status, you suddenly pay at least $800 in franchise taxes. They get you… always… eventually.

To summarize some of these various terms that you might hear-

• FUTA and SUTA- unemployment tax. Unavoidable. You might be able to opt out, and as the Minnesota example above illustrates, there is a tax savings by doing so.

• SDI- state disability insurance. Might be able to opt out for single-owner corporate officers in California or with supplemental insurance.

• Workers Compensation Insurance-has nothing to do with unemployment or state disability insurance, and is not interchangeable with those terms. This is purely insurance coverage for on-the-job injuries and is provided by private insurance such as State Farm, All State, Farmers, etc.Washington state runs their own program but allows business owners to opt-out. Ask your local insurance agent if you can opt out. Typically, you can since you don’t plan on suing yourself for a paper cut or a rogue paperclip stabbing.

Be aware that additional payroll taxes can nibble at the S Corp savings, but frankly it is relatively small at approximately $500. We are not trying to value-assess your money since $500 is still a big number. However, it is dwarfed by the savings.