The Unemployment Insurance Modernization and Recession Readiness Act, S. 3140[1] and H.R. 6071,[2] introduced on October 26, 2023, would infuse a critical element of the Richard L. Trumka Protecting the Right to Organize Act of 2023, H.R. 20, and S. 567, into state unemployment statutes. The bill would, among other things, strongly encourage states to amend their respective state unemployment statutes to adopt the following “ABC” test for the term employee:
an individual performing any service shall be considered an employee and not an independent contractor for the purpose of the State law, unless—
(A) the individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of service and in fact;
(B) the service is performed outside the usual course of the business of the employer; and
(C) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed
The bill would accomplish this through the special statutory relationship between federal and state governments that the Federal Unemployment Tax Act of 1939 (“FUTA”) created to accomplish the joint federal and state funding of state unemployment benefits.
- The Federal-State Partnership Governing Unemployment Programs
By way of background, state unemployment programs are funded through payroll taxes imposed by the federal government, in the form of FUTA taxes, and by states, in the form of SUTA taxes. Both FUTA taxes and SUTA taxes are excise taxes imposed on covered employers with respect to their employees.
Generally, FUTA taxes collected are used to pay state administrative costs, one half the cost of states’ extended benefits (“EB”), and any loans to insolvent state unemployment programs. SUTA taxes collected are used to pay a state’s regular unemployment benefits and one half the state’s EBs.[3]
- Congress’s Power to Influence State Unemployment Tax Statutes
FUTA taxes are imposed on an employer at the rate of 6% on the first $7,000 of wages the employer pays each of its employees during a calendar year. See, sections 3301 and 3306(b)(1) of the Internal Revenue Code (the “Code”).
Code section 3302(a) and (b) provide that an employer may claim a credit against its FUTA tax liability for a calendar year by the amount of SUTA taxes it paid for the year (referred to as the “normal” credit) and by an additional amount that is available to employers with a low incidence of unemployment (referred to as the “additional” credit). Code section 3302(c)(1) provides that these credits, taken together, can decrease an employer’s FUTA tax rate by up to 90%. Thus, these credits can reduce an employer’s 6% FUTA tax rate to a 0.6% tax rate.
But to encourage states to establish an unemployment program that complies with the framework that Congress establishes, Code section 3302(a)(1) provides that for an employer to be eligible to claim these credits, the SUTA taxes the employer pays must be paid to a state that maintains an unemployment program in conformance with Code section 3304(a).[4]
At this time, all states comply with the Code section 3304(a) mandates governing state unemployment statutes. As a practical matter, a state whose unemployment statute does not comply would be at a significant competitive disadvantage relative to all other states because the employers in its state would be ineligible for the credit that could reduce their FUTA tax rate from 6% to 0.6%.
Accordingly, Code section 3304(a) represents de facto federal preemptive power over state unemployment statutes. But hitherto Congress has exercised restraint and not abused this power. Instead, Congress has granted states significant flexibility in designing their own unemployment statutes. The Congressional Research Service observed in a 2016 report:
There remains significant state independence within the broad parameters set by FUTA. States generally determine individual qualification requirements, disqualification provisions, eligibility, weekly benefit amounts, potential weeks of benefits, and the state tax structure used to finance all of the regular state UC benefits and half of the EB.[5]
States exercise their independence in this area through the enactment of their respective state unemployment statutes addressing the referenced unemployment-program features.
- Pressuring States to Adopt an “ABC” Test for Unemployment Purposes
Congress historically has recognized the right of each state to adopt its own definition of the term employee for purposes of its unemployment statute. The bill would change this. It would amend Code section 3304(a) to include the “ABC” test set forth above. Thus, a state would need to amend its state unemployment statute to adopt that specific “ABC” test for the term employee, in order for employers in the state to remain eligible for a credit that could reduce their FUTA tax rate from 6% to 0.6%.[6] Such a change would materially expand the category of individuals who would be deemed employees for purposes of state unemployment throughout the nation.
The foregoing is intended solely as general information and may not be considered tax or legal advice; nor can it be used or relied upon for the purpose of (i) avoiding penalties under any taxing statute or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. You should not take any action based upon any information contained herein without first consulting legal counsel familiar with your particular circumstances.
[1] S. 3140 was introduced by Senator Ron Wyden (D-OR).
[2] H.R. 6071 was introduced by Rep. Donald Beyer (D-VA).
[3] CRS Report R44527, Unemployment Compensation: The Fundamentals of Federal Unemployment Tax (Oct. 25, 2016).
[4] In this regard, Code section 3304(c) provides that on October 31 of each taxable year, the Secretary of Labor shall certify to the Secretary of the Treasury each state whose law has been deemed compliant with the Code section 3304(a) requirements.
[5] Id (emphasis added).
[6] Some states have adopted a version of an “ABC” test for the term employee, but many others have not. And of those states that have adopted a version of an “ABC” test, most adopted a narrower version than what the bill would require or an “AB” test.
