Human Cost

This story appears in the November 2005 issue of Entrepreneur. Subscribe »

Don't be tempted to avoid paying state unemployment taxes: A year-old federal law gives state officials the right to seek unpaid taxes and impose penalties on companies that avoid unemployment taxes, a maneuver that's been dubbed "SUTA (state unemployment tax acts) dumping." These taxes are used to finance state trust funds that pay benefits to workers who lose their jobs.

The law eliminated some of the most flagrant SUTA-dumping techniques, such as creating a shell corporation to wipe out a company's high unemployment experience rating. Current law says a company's unemployment experience rating, which is based on the number of unemployed workers the company has created in the past, must be transferred when employees move from one business to another owned or controlled by the same employer.

However, some employers are using a new loophole to avoid paying unemployment taxes. Namely, employers are signing up with employee-leasing or professional employer organizations, putting their workers on the PEO's payroll and then leasing them back. Employees are dumped from an existing business to a PEO, giving their employer a low unemployment experience rating. As a result, employers don't pay the taxes they actually owe as determined by their true unemployment experience.

"The PEO loophole needs to be eliminated nationwide," says attorney Rick McHugh with the National Employment Law Project, an advocacy group in Dexter, Michigan. He also contends that states should adopt the penalties proposed by the U.S. Labor Department for SUTA- dumping violations. These penalties include a maximum tax rate or a 2 percentage point increase in their existing rate, which-ever is higher, for four years.

In the meantime, if you're thinking of using these maneuvers to avoid unemployment taxes, think again. If your state catches you involved in an illegal tax-avoidance scheme, you'll have to pay the taxes you failed to pay, plus penalties, which could add up fast.