# Tax strategy: Prepay unemployment tax and save later

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Sometimes, the money spent now can save valuable tax dollars in the near future. It may even defy conventional logic. Case in point: Generally, companies are required to pay tax into a state unemployment insurance fund. The pay-in amount is usually determined by the ratio of payroll to the reserve in the company's account.

Strategy: Advocate making voluntary contributions this year. By taking this proactive approach, the employer increases the reserve amount in the account. And, if things are figured correctly, the reserve can be pushed up just enough to pull down the company into a lower tax bracket next year.

An employer can save hundreds of tax dollars by using this "push-and-pull" strategy at the end of the year. Example: Early bird catches the worm Say XYZ Corp. has a taxable annual payroll of \$250,000 and a net credit of \$24,900 in its unemployment tax account.

At the current payroll-to-credit ratio, the company must pay unemployment tax of \$1,500 a year. But if XYZ had a credit of \$25,000—or just \$100 more—the tax bill would be cut in half to \$750.

So, assuming the state allows voluntary contributions, XYZ's managers should kick in an extra \$100 to qualify for the lower tax rate. Result: The net savings from the voluntary contributions amount to \$650 (\$750 tax savings minus \$100 additional contribution).

How much is needed to contribute to the unemployment fund to reduce the tax rate? The state will notify employers about the reserve balance in an unemployment insurance account.

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When you compare this figure to the average payroll (in some states, the average taxable payroll is the critical figure), you can determine the reserve ratio.

Tip: The states regularly publish tables indicating how the tax rates line up for employers with different reserve ratios.

Crunch the numbers first

This tax strategy only works if the account is near the threshold for a lower unemployment tax bracket. In the example above, if XYZ had to contribute an extra \$1,000 to drop it into a lower tax bracket, it wouldn't be worth it. It would lose \$250 overall (\$1,000 additional contribution minus \$750 tax savings).

Another potential downside: By reducing the tax rate for next year, the company may end up paying a higher tax rate in future years. The lower tax bracket will reduce the flow of funds into the unemployment insurance account. Still, employers are usually better off paying less tax now and using the savings for working capital.

Advisory: When permitted under state law, an employer should condition acceptance of the voluntary contribution on an actual decrease in its unemployment insurance tax rate. To be deductible for federal income taxes, the extra contribution must reduce the tax rate.

Online Resource:

To find the applicable state unemployment tax rate for a particular state, visit the Tax Policy Center.

Reprinted with permission from The Tax Strategist, October 2008. For continuing advice on this and numerous other tax strategies, go to www.TaxStrategist.net. Receive 2 FREE Bonus Reports and a 40% discount on The Tax Strategist when you use Promo Code WN0013.