Question

In: Accounting

In this lesson, you visited Employment Taxes - Reimbursement Payment Option on the Arizona Department of...

In this lesson, you visited Employment Taxes - Reimbursement Payment Option on the Arizona Department of Revenue Web site. Use the information on the site to answer the following questions:

Why would a nonprofit organization choose to elect the reimbursement payment option versus paying unemployment tax on the first $7,000 of each employee's payroll? Explain your answer.

What are the advantages and disadvantages for electing the reimbursement payment option? If you had to choose, would you use the reimbursement payment option? Why or why not?

Solutions

Expert Solution

Reason for opting reimbursement option by Non profit organisation:-

1) Nonprofits that qualify as Section 501(c)(3) organizations need not pay federal unemployment taxes. However, in most cases they must pay state unemployment tax, unless they choose the alternative payment option discussed below. State unemployment taxes can be a real burden.The US Department of Labor calculates FUTA taxes in the first quarter for the prior taxable year. The FUTA tax is 6.0% of the first $7,000 in wages paid to each employee but employers paying their taxes in-full and timely receive a 5.4% credit. Therefore, in normal times, employers pay 0.6% in FUTA taxes.

2) They are based on your nonprofit’s payroll and claims history—employers with many claims pay higher taxes than those with few claims. Unfortunately, these taxes are likely to get worse. With unemployment still high, most states are currently paying out far more in unemployment benefits than they are receiving in revenue.

3) A 501(c)(3) organization has the option of opting out of its state unemployment insurance program. Instead of paying a set amount of unemployment tax to the state every year regardless of how many of its employees file claims, it reimburses the state only for unemployment claims the state actually pays out to its former employees. This can save big money because nonprofits typically pay more in unemployment taxes than the state pays out for the nonprofit's former employees’ claims. In the past, many nonprofits have saved 30% to 40% over five to ten years.

4) But there are obvious risks to this approach. If your nonprofit is forced to lay off substantial staff, the unemployment costs it will have to reimburse the state could far exceed the unemployment tax it would otherwise have had to pay. This risk is doubtless greater now than in the past because so many nonprofits are experiencing declining funding. To mitigate these risks, thousands of nonprofits have joined grantor trusts that pool money from many organizations to pay off future claims.

Advantages & Disadvantages of Paying Reimbursements:-

To choose to become a reimbursing employer is comparable to making a decision to discontinue carrying casualty insurance. If no casualty occurs, the cost of the premium has been saved. Below are matters to consider when choosing an election.

Advantages:-

1) If no benefits are paid to a former employee of a reimbursing employer, the organization will have no reimbursements to pay.

2) Even if some benefits are paid, the amount of reimbursements to be paid over a period of time may be less costly than payment of the tax for the same period.

Disadvantages:-

1) To elect to become a reimbursing employer is comparable to making a decision not to carry auto insurance. One's liability may be much greater.

2) A taxed employer normally knows in January of each year their tax rate for the calendar year whereas a reimbursing employer never knows their potential liability and may be required to pay reimbursements more than two years after the individual has been separated from their employment.

3) A reimbursing employer may be required to post a surety bond to insure that reimbursements are made. It is possible that the cost of such a bond could be greater than the tax.

The reimbursement option works best for larger nonprofits with stable employment. Nonprofits with fewer than ten employees or that have regular layoffs, are usually not good candidates for opting out of state unemployment taxes.




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