Federal Unemployment Tax Has Changed: How Does it Affect You?

On July 1, 2011, the federal unemployment tax rate dropped from 6.2 percent to 6 percent (not retroactive to the beginning of the year). The difference is minor, but a small tax decrease is better than none at all.

Depending on the circumstances, an employer could save $0 to $14 per year per employee. Federal unemployment tax, or FUTA is paid on the first $7,000 of wages per employee, per year, so for employees who have surpassed the $7,000 mark before July 2011, no savings will be realized.

Unfortunately for employers in certain states that have been hit by unusually high unemployment claims, the net FUTA rate will still increase.

To better understand the changes, here is some background information on how the FUTA system works.

Employers pay both state unemployment tax and federal unemployment tax. The IRS grants a credit for 5.4 percent for the payment of state unemployment tax, which nets against the FUTA rate.

Using the old FUTA rate of 6.2 percent, for wages paid from January to June 2011:

6.2 percent minus the credit of 5.4 percent = .8 percent. .8 percent times $7,000 equals $56 per employee per year. So for an employee who began work, for example, in January of 2011 and earned $7,000 or more before July, the total FUTA owed by the employer for the year would be $56. Using the new FUTA rate of 6 percent, for wages paid from July through December 2011:

6.0 percent minus the credit of 5.4 percent = .6 percent. .6 percent times $7,000 equals $42 per employee per year. So for an employee who began work on or after July 1, 2011 and earned $7,000 or more during the year, the total FUTA owed by the employer would be only $42, a savings of $14 compared to the old rate.

Now for the Bad News

All employers get the FUTA reduction of .2 percent, described above. Despite the reduction, in some states, employers will still pay more FUTA for 2011 and possibly 2012 and beyond. The reason is due to unprecedented unemployment claims in many areas of the country. As a result, 20 states and the Virgin Islands depleted their unemployment insurance funds and had to draw on a designated federal loan account. If these loans are not repaid within two years, the borrowing states lose part of the 5.4 percent FUTA tax credit granted by the IRS, until the loan is repaid. Each year until the loan is repaid, the tax credit is reduced by .3 percent. The net effect is that employers in the affected states pay more FUTA.

Some Examples

For employees who earned at least $7,000 before July, the FUTA tax rate starts at .8 percent, as shown above. In affected states, employers must pay .8 percent plus an additional .3 percent, for a total of 1.1 percent.

$7,000 times .011 equals $77 per employee per year. This is $21 more than employers in unaffected states will pay per employee for that time period. Let’s look at an employee who was hired in July and earned at least $7,000 before the end of the year. For that employee, employers in affected states would pay the regular FUTA tax rate of .6 percent, plus an additional .3 percent, for a total of .9 percent.

$7,000 times .09 percent equals $63 per employee per year. Again, this is $21 more than employers in unaffected states will pay per employee for the same time period. Which States and Territories Are Affected?

They are Arkansas, California, Connecticut, Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Virginia, Virgin Islands, and Wisconsin.

In addition, the state of Indiana is in its second year of credit reduction (now subject to the regular FUTA tax plus .3 percent for 2010 and another .3 percent for 2011), and the state of Michigan is in its third year of credit reduction (now subject to FUTA tax plus .3 percent for 2009, plus .3 percent for 2010, plus .3 percent for 2011).

The states of Alabama and South Carolina also took federal loans but have now met the requirements to avoid the credit reduction for 2011.

What is the FUTA Outlook for 2012?

The FUTA tax rate is expected to remain at .6 percent of wages up to $7,000 per employee. Employers that are in states currently subject to a credit reduction can expect FUTA to rise again by another .3 percent, unless the state is able to repay the loan or take other actions specified by federal law to avoid this penalty.

If you have questions about FUTA, consult with your payroll or tax adviser for more information.

Go on the Defense with an Escalation Clause

Contractors everywhere have experienced the pain of rising construction materials costs and less work, putting their businesses in financial jeopardy. How can you fight back? Include an escalation clause in your job contracts.

How does it work?

Without getting into too much legalese, an escalation clause specifies that, in the event materials costs rise beyond a specified amount, you may pass those costs along to the project owner.

For many years, such clauses have been fairly common in larger, long-term jobs. But as materials cost have risen, contractors have started adding escalation clauses to virtually any size contract — from single-family homes to commercial high-rises to mixed-use developments .

What’s driving up the price of construction materials nowadays? Many blame a building boom overseas, particularly in China. Others point to environmental reasons — loss of forestlands driving up lumber prices, for instance. And, of course, transporting materials is always an issue because of fuel costs. For all those reasons, an escalation clause is especially important.

To make it through contract negotiations — and to increase the likelihood of being upheld in court should litigation arise — an escalation clause must clearly define the materials in question and specify the “triggering event” that activates the clause. Atypical triggering event is a 2% or 3% rise in the originally estimated materials cost.

Moreover, the U.S. Department of Labor (DOL) Bureau of Labor Statistics notes in its PPI Program Spotlight No. 98-1, that “an escalation clause should specify whether price adjustments are to be made at fixed intervals, such as quarterly, semi-annually or annually, or only at the expiration of the contract.”

Perhaps most important, though, is that the clause describe the method used to calculate the escalation.

How is the escalation calculated?

Several methods are commonly used when setting the escalation. The simplest is the “invoice” method, in which you use a supplier invoice or other like document to substantiate a materials price change.

You might also use a widely accepted, published price index to support your claim. Such indexes are typically available for materials such as lumber, cement and steel. However, the DOL warns that any given index might not be available for a particular time period either because price information wasn’t supplied by enough survey respondents to meet publication standards, or the index was discontinued because of a decline in the commodity’s importance in the marketplace. And it’s also possible that any particular index doesn’t accurately account for localized cost variations.

A third option is a hybrid approach. Under one such approach, the triggering event is specified as an increase under both the invoice method and the index method. Another hybrid approach involves subjecting the invoice method to a limit based on a widely accepted index.

In any case, the rationale behind these hybrid approaches is to provide a sort of check and balance on invoices by ensuring that the supplier’s prices aren’t widely different from market prices. Work with your CPA to determine an accurate method of calculating any materials price escalations.

What are the risks?

Perhaps the biggest risk of an escalation clause is that its inclusion in the contract will stall negotiations or quash the project entirely. The right contract language, as well as full disclosure and open discussion of the matter, however, can go a long way toward assuaging any owner fears about the clause.

Another risk is mishandling a claim should one arise. If you decide to take the plunge and write an escalation clause into a contract, be sure to document your materials acquisitions and costs carefully.

What’s the bottom line?

Despite the recession, the rising cost of building materials is still an issue. If you don’t take steps to contain those costs — via an escalation clause — your construction firm may suffer financial repercussions. Because such clauses are part of contract law, make sure you work with a qualified attorney when developing the contract.