Nonprofits have two options for dealing with unemployment claims. They can pay fees based on experience and payroll into a state unemployment program or opt to reimburse the state for actual claims. Here are some basics to help you explore the options for your nonprofit.
Through an exception in federal tax law, nonprofits have the option to pay for unemployment claims via state unemployment insurance tax or to reimburse the state annually for actual unemployment claims paid on behalf of the nonprofit. In the latter, the nonprofit acts as a reimbursing employer. This option was established because nonprofits tend to have lower involuntary turnover and fewer unemployment claims.
Paying actual claims versus a tax rate set by the state typically results in a savings that can help improve cash flow. However, tracking and administering payments can be challenging, so many nonprofits outsource these efforts to nonprofit unemployment trusts.
Unemployment trusts hold funds set aside for expected future claims. The trusts are often set up by an external administrator that maintains documentation, pays and keeps track of claims, and establishes contribution amounts required to cover future liabilities.
There are several reasons why an organization might choose an unemployment trust. For one, payments to the state effectively amount to a payroll tax. Once those funds go to the state, the organization cannot recover them if actual unemployment costs are lower than the payments into the program. Also, since the payment to the state is a percentage of payroll, organizations with staff growth are paying based on a larger base that is not immediately factored into the rate.
With an unemployment trust, contributions are used to pay claims, and what remains are still the organization’s assets since the trusts are revocable. Payments into the trust are usually made quarterly – not with each payroll or by the month, as is done with state unemployment payments. This provides a cash flow benefit to the organization which increases as the trust balance builds.
Another benefit of unemployment trusts is better access to information for planning. With state unemployment insurance, the state sets the rate annually; the organization has little visibility into the factors and calculations. With an unemployment trust, the administrator can provide detailed analysis of contributions and projections for planning purposes.
While unemployment trusts can provide valuable benefits, there are some drawbacks. As a reimbursing employer, the organization gives up the right to contest an unemployment claim. This can cause the organization to pay for a claim filed by an employee who was terminated for cause or who left voluntarily. In both of these cases, if the organization was paying state unemployment insurance, the claims could be challenged.
Another drawback is the limited understanding of unemployment trusts within many nonprofits. Even organizations that participate in these programs rarely have a good understanding of the operational side and impacts. Balances build slowly and are often off book, so they are mostly overlooked until they become significant.
Also, accounting for unemployment trusts is somewhat more complicated. Paying into a state unemployment fund is simple because the payment is expensed when paid. In organizations with small unemployment trust balances, the process is done similarly – contributions into the trust are expensed when made. That treatment is not correct.
Since the trust is revocable, the balance should be reflected in the financial statements as an asset. Contributions into the trust should be recorded as an asset transfer from cash to trust asset. On a regular basis, payments made by the trust for unemployment claims and payments expected within the current year should be expensed with an offsetting credit to the trust asset.
Unemployment trusts are a useful tool used to manage expense and cash flow related to unemployment claims. As an alternative to paying into state unemployment insurance funds, becoming a reimbursing employer for unemployment charges can provide better information for forecasting and gives nonprofits some level of control over the amount and timing of payments.
The additional efforts associated with being a reimbursing employer can be minimized by outsourcing transactional tasks with an administered unemployment trust. The trust holds contributions from the nonprofit for expected future unemployment claims but distributes only actual claims as a reimbursement after the fact.
Unemployment trusts are an option exclusively for nonprofits, so for CPAs who support nonprofits it is worth your time to figure out if this option will add value to your organization.
Michael F. Cade, CPA, CGMA, is a strategy consultant and executive coach for MFCCoach LLC in Morrisville, chair of PICPA’s Not-for-Profit Committee, and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.