WikiLeaks Document Release
http://wikileaks.org/wiki/CRS-RS22069
February 2, 2009
Congressional Research Service
Report RS22069
State Unemployment Taxes and SUTA Dumping
Steven Maguire, Government and Finance Division; and Julie M. Whittaker, Domestic Social Policy
Division
May 27, 2005
Abstract. This report provides a summary of the State Unemployment Tax Acts (SUTA) Dumping Prevention
Act of 2004, P.L. 108-295. The term SUTA dumping refers to a variety of tax planning strategies used by
employers to minimize the tax burden of federally mandated state unemployment taxes. The strategies exploit
the differences in methods state employ to determine unemployment tax rates among established employers
and the method by which states determine the tax rate of new firms and firms that have either created
new subsidiaries or have absorbed other firms. SUTA dumping creates tax inequities when firms avoid their
appropriate state unemployment taxes. Firms that follow state unemployment tax law are burdened with
additional taxes as a result of the tax avoidance by the firms that engage in SUTA dumping.
Order Code RS22069
Updated May 27, 2005
CRS Report for Congress
Received through the CRS Web
State Unemployment Taxes
and SUTA Dumping
Steven Maguire
Analyst in Public Finance
Government and Finance Division
Julie M. Whittaker
Analyst in Applied Microeconomics
http://wikileaks.org/wiki/CRS-RS22069
Domestic Social Policy Division
Summary
This report provides a summary of the State Unemployment Tax Acts (SUTA)
Dumping Prevention Act of 2004, P.L. 108-295. The term "SUTA dumping" refers to
a variety of tax planning strategies used by employers to minimize the tax burden of
federally mandated state unemployment taxes. The strategies exploit the differences in
methods state employ to determine unemployment tax rates among established
employers and the method by which states determine the tax rate of new firms and firms
that have either created new subsidiaries or have absorbed other firms. SUTA dumping
creates tax inequities when firms avoid their appropriate state unemployment taxes.
Firms that follow state unemployment tax law are burdened with additional taxes as a
result of the tax avoidance by the firms that engage in SUTA dumping. This report will
be updated as legislative activities warrant.
Overview
The Unemployment Compensation (UC) Program. UC is a joint federal-
state program and is financed by federal taxes under the Federal Unemployment Tax Act
(FUTA) and by state payroll taxes under the State Unemployment Tax Acts (SUTA). The
underlying framework of the UC system is contained in the Social Security Act (SSA).
Title III authorizes grants to states for the administration of state Unemployment
Compensation (UC) laws; Title IX authorizes the various components of the federal
Unemployment Trust Fund (UTF); and, Title XII authorizes advances or loans to
insolvent state UC programs.
UC Financing. Among its 59 accounts, the federal UTF in the U.S. Treasury
includes the Employment Security Administration Account (ESAA), the Extended
Congressional Research Service ~ The Library of Congress
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Unemployment Compensation Account (EUCA), and the Federal Unemployment
Account1 (FUA), 53 state accounts,2 the Federal Employees Compensation Account
(FECA), and two accounts related to the Railroad Retirement Board. Federal
unemployment taxes are placed in the ESAA, the EUCA, and the FUA; each state's
unemployment taxes are placed in the appropriate state's account. Federal taxes pay for
UC administration grants to the states and half of extended UC benefits. State taxes pay
for regular UC benefits and half of extended UC benefits.
What is SUTA Dumping?
The term "SUTA dumping" refers
to a variety of tax planning strategies Federal Unemployment Taxes. A
federal tax of 6.2% on the first $7,000 of a
used by employers to minimize state worker's wages ($434 per worker) is levied on
unemployment taxes. The strategies employers. The employer, however, receives a
exploit the variation in the effective federal tax credit of up to 5.4% ($378) of the
unemployment tax rates among worker's wages for state unemployment taxes.
Employers may have a state unemployment tax
employers and the methods states rate that is less than $378 that may be credited
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determine the tax rate of firms that have toward the federal tax as long as the state's UC tax
either created new subsidiaries or have system complies with federal law. The federal
absorbed other firms. Unemployment government receives up to $56 per covered
taxes are levied on employers based on worker from employers.
a combination of established rates and State Unemployment Taxes. State tax
the employer's past history with the UC rates and base wages are determined by wildly
system. Generally, employers that have variable state law. In 2004, the wage base ranged
had a greater number of unemployed from $7,000 (11 states) to $27,100 (Alaska).
Three states, Alaska, New Jersey, and
workers in the past have a lower rating
Pennsylvania, also tax employees to finance the
and would pay higher UC taxes. UC fund. Most states augment the base funding
formula through expanding the taxable wage base,
Recently, Congress passed the increasing tax rates, and/or levying special fund
SUTA Dumping Prevention Act of 2004 fees. In addition, all states use an experience
rating to adjust an employer contribution to better
(P.L. 108-295), which is intended to end reflect the employer's potential reliance on the
or at least significantly curtail SUTA fund. New firms, those with no past
dumping. SUTA dumping occurs when unemployment experience, may be levied a lower
employers that pay relatively high UC tax rate (less than the 5.4% but not less than 1%)
taxes, "dump" workers into an affiliated than employers with more experience.
employer with lower UC taxes. The
legality of SUTA dumping schemes
varies depending on state laws. According to a Government Accountability Office (GAO)
survey, over half of the state administrators felt that SUTA dumping resulted in lost state
unemployment tax revenue. Administrators most often cited the employee leasing
industry, hospitality industry, and construction industry as engaging in SUTA dumping
practices.3
1
The FUA is an account from which advances are made to depleted state trust fund accounts to
ensure that UC benefit obligations are met.
2
The District of Columbia, Puerto Rico, and the Virgin Islands are considered to be states.
3
U.S. Congress, House Committee on Ways and Means, Subcommittee on Oversight and
(continued...)
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The state unemployment tax rate of an employer is, in most states, based on the
amount of UC paid to former employees. Generally, in most states, the more UC benefits
paid to its former employees, the higher the tax rate of the employer, up to a maximum
established by state law.4 The experience rating is intended to ensure an equitable
distribution of UC program taxes among employers and encourage a stable workforce.
The variation of experience rates creates the opportunities for strategic tax minimization
behavior, such as "SUTA dumping."
Currently, four experience rating systems are used by states to establish an
employer's experience rating: reserve ratio, benefit ratio, benefit-wage ratio, and payroll
variation. Each system is intended to fairly distribute the burden based on an employers
unemployment history. The focus here will be on the reserve ratio (RR) and benefit ratio
(BR) systems because 30 and 17 states, respectively, use these systems.5 How these tax
rates are determined when employers merge or new employers acquire predecessor firms
are the basis of most SUTA dumping cases.
Reserve Ratio (30 states, DC, PR, and VI). The most common formula is the
reserve ratio. Each employer's rate is calculated as the contributions less UC benefits
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paid divided by payroll. Stated differently, it is the employer's historical "net" UC
balance divided by total payroll. Most states require employer's to use all past years when
calculating the experience rating. Using all past years tends to minimize the volatility in
the ratio resulting from business cycle fluctuations.
Benefit Ratio (17 states). The second most common formula is the benefit ratio.
The employer's tax rate under the BR system is calculated as the UC benefits paid divided
by total payroll. In contrast to the RR system, the BR system uses the most recent
experience, typically the previous three years, to establish the tax rate. The emphasis on
more recent experience makes the BR system more sensitive to the business cycle. The
pro-cyclical nature of the BR system -- UC taxes increase when UC benefits paid
increase -- may impede economic recovery.
Employer Experience Rating Transfers. According to the U.S. Department
of Labor (DOL), the transfer of case records, necessitated by firm acquisition and mergers,
is automatic in most states.6 Acquiring firms simply incorporate the predecessor's case
3
(...continued)
Subcommittee on Human Resources, Testimony of Robert J. Cramer, Managing Director Office
of Special Investigations, Government Accountability Office, June 19, 2003, (GAO-03-819T).
(Hereafter cited as GAO, 2003, at [http://www.gao.gov/new.items/d03819t.pdf].)
4
FUTA, in Section 3303(a), allows credit for a lowered rate of contribution if the rates are based
on at least three years of UC program experience. Federal law allows states to make new firms
eligible for reduced rates after one year. Federal law also allows states to offer new employers
a reduced rate immediately; however, the rate must be at least 1%.
5
The District of Columbia, Puerto Rico, and the Virgin Islands, all use the reserve-ratio system.
Delaware and Oklahoma use the benefit-wage-ratio and Alaska uses the payroll variation system.
Please refer to U.S. Department of Labor, Comparison of State Unemployment Insurance Laws
2005, chapter 2, page 9, for a description of the other two systems.
6
U.S. Department of Labor, Comparison of State Unemployment Insurance Laws 2003, Chapter
(continued...)
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records when determining the appropriate experience tax rate. Variation among the states
occurs in the treatment of transferred employees and how new employers are taxed; this
generates opportunities for strategic tax planning like SUTA dumping.
Methods of SUTA Dumping
There are three basic methods for engaging in SUTA dumping: vertical, horizontal,
and acquired rate. A brief description of each method follows below.
Create a New Business (Vertical Method). An employer with a high level of
UC use can minimize the impact of a poor UC experience rating (and accompanying
higher UC taxes) by setting up a new company and gradually transferring some, or all, of
its workforce (and accompanying payroll) to the new company with its lower `new firm'
UC tax rate. The DOL, Office of the Inspector General found this to be a typical method
for the employee leasing firms. In one state, it found it to cause "major" losses to the
state's UTF.7
Transfer Payroll to a Subsidiary (Horizontal Method). Firms move
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employees from one unit that has experienced sizable layoffs to a different unit with a
relatively lower rate of layoffs, reducing the unemployment-tax bill. Over time, as
employees continue to be transferred, the first unit would be eliminated, along with the
high turnover rate that boosted unemployment taxes.
Purchasing an Existing Business (Acquired Rate Method). Under this
scheme, a new business purchases an existing small business with a low UC tax rate.
However, the acquisition is not for legitimate business reasons but rather is a shell
transaction designed to lower the firm's UC tax rate. This strategy exploits the existing
business's tax rate that is lower than the state's new business tax rate. The newly formed
entity receives the predecessor's lower rate. The new business often does not engage in
substantially the same business activity as the predecessor business.
What is Currently in Place to Detect and Minimize SUTA
Dumping?
Presently, states detect potential SUTA dumping schemes by manually reviewing
employer tax records. The DOL developed an automated SUTA Dumping Detection
System in a pilot program where seven states8 were selected for testing. According to
DOL,9 the testing is complete and the detection system ready to be distributed to the
states. The automated detection system extracts information from tax files, produces a
6
(...continued)
2, pp. 24-27.
7
U.S. Department of Labor, Office of Inspector General, Unemployment Insurance Integrity:
Fraud and Vulnerabilities in the System, No. 1P-03-315-0001-PE, Mar. 31, 1999, p. 7, at
[http://www.itsc.org/PDF/OIG_UI_Paper.pdf].
8
Nebraska, North Carolina, Rhode Island, Texas, Utah, Virginia, and Washington.
9
Telephone conversation with the U.S. Department of Labor, Employment and Training
Administration, on May 17, 2005.
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prioritized list of employers, estimates the potential loss of UC revenue, and creates a
report for further investigation. States received information on how to submit a
supplementary budget request for implementing the detection system and the requests are
due in June 2005.
States have a variety of measures in place to minimize SUTA dumping. According
to the GAO, in 2003, 21 state UC administrators reported that their programs have no
laws specifically addressing SUTA dumping. Twenty-nine state administrators indicated
that they have laws addressing SUTA dumping, but seven of them felt that those laws
were inadequate. Approximately two-fifths of the administrators indicated that their states
are adequately addressing the problem or that they do not know of any SUTA dumping
in their states.10
The manner in which states treat new, successor, and predecessor firms may deter
SUTA dumping. In the GAO survey, UC administrators in 20 states reported that other
state laws, often those dealing with employer succession, adequately address SUTA
dumping practices. These states cite their employer succession laws as protection against
such practices because they require the transfer of experience ratings from one company
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to a successor company when ownership or management is substantially the same.11
Listed below are the administrative considerations that states (indirectly) use to address
the forms of SUTA Dumping.
New Firms. Federal requirements do not allow an experience rating to be granted
unless the state has at least a one-year record of the employer's experience. Without such
a record there would be no basis for rate determination. However, states are allowed to
give new firms a "new firm" experience rating that may be lower than the expected tax
for the firm (perhaps because it is in an industry that has a high use of the UC system).
Successor Firms. Most states have statutes or regulations that determine the rate
to be assigned the successor employer from the date of the transfer to the end of the rate
year in which the transfer occurs. The rate assignments vary with the length of time since
the acquisition of the firm. Over half of the states require that an employer who has a rate
based on actual UC experience must continue to pay that rate for the remainder of the rate
year. If the predecessor firm had a much higher unemployment tax rate, this may
encourage SUTA Dumping. Other states assign a new rate based on a combination of the
employer's experience and the acquired firm's experience.
Predecessor Firms (Addresses Acquired-Rate Method). All state laws
specify the conditions under which the experience rating of a predecessor employer may
be transferred to an acquiring employer. In some states, the authorization for transfer of
the rating is limited to total transfers (i.e., the record may be transferred only if a single
successor employer acquires the predecessor's organization and substantially all of its
assets). Other states authorize partial as well as total transfers where the proportion of the
predecessor's record that pertains to the acquired portion of the business may be
transferred to the successor. Some states condition the transfer of the experience rating
on what happens to the business after it is acquired by the successor. For example, in
10
GAO, 2003.
11
Ibid.
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some states, there can be no transfer if the enterprise acquired is not continued; in three
of these states,12 the successor must employ substantially the same workers.
New Requirements to Limit SUTA Dumping
The SUTA Dumping Prevention Act (P.L. 108-295). The SUTA Dumping
Prevention Act requires that states develop standards for employee transfers and impose
penalties on firms and advisory groups that promote SUTA dumping techniques as a tax
avoidance tool and to impose meaningful penalties on those firms and people who either
advise or implement SUTA dumping schemes. P.L. 108-295 permits states to use certain
information in the National Directory of New Hires from the Social Security
Administration in the administration of federal and state UC laws.13 P.L. 108-295 also
requires the U.S. Secretary of DOL to submit to the Congress, not later than July 15,
2007, a report that (1) assesses the statute and appropriateness of state actions to meet its
new requirements; and (2) recommends any further congressional action that the Secretary
considers necessary to improve the effectiveness of the amendments.14 In the
Unemployment Insurance Program Letter No.30-04, DOL provided draft legislative
language for the states that DOL felt would comply with the intent of P.L. 108-295.15
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The changes in the state laws are expected to be complete by the end of FY2006.
States generally have followed DOL guidelines, although there is variation. According
to DOL16 the following states have enacted legislation: Arizona, Arkansas, California,
Georgia, Idaho, Indiana, Kansas, Kentucky, Michigan, Mississippi, Montana, New
Mexico, North Dakota, South Carolina, South Dakota, Utah, Virginia, Washington, and
Wyoming. As of May 16, 2005, seven additional state legislatures (Colorado, Florida,
Hawaii, Maryland, Nevada, Oklahoma, and Oregon) have passed SUTA dumping
legislation but the legislation has not been signed by the respective governors.
12
California, District of Columbia, and Wisconsin.
13
The Office of the Inspector General of DOL found the New Hire detection system is more
effective and efficient than the earlier crossmatch system in identifying UC overpayments that
occur when UC claimants fail to report earnings while simultaneously working and claiming
benefits. Most, but not all states, now use the New Hire detection system. The report also
recommended that DOL encourage state UC programs to access the NDNH and coordinate
efforts with the Department of Health and Human Services and the state UC programs to
accomplish full integration. U.S. Department of Labor, Office of Inspector General, Office of
Audit, Unemployment Insurance Benefit Payment Control New Hire Detection Is A Better
Method For Establishing UI Overpayments Than The Wage/UI Benefit Crossmatch, No.
05-04-002-03-315, Sept. 30, 2004.
See [http://www.oig.dol.gov/public/reports/oa/2004/05-04-002-03-315.pdf].
14
See Section 2(b) of P.L. 108-295.
15
See [http://www.ows.doleta.gov/dmstree/uipl/uipl2k4/uipl_3004a2.htm].
16
Telephone conversation with the U.S. Department of Labor, Employment and Training
Administration, on May 17, 2005.