Unemployment benefits – funding that you and your employer pay into – are disbursed to eligible workers through application to the state in which you worked. The Federal Unemployment Tax Act (FUTA) is the fund to which employers deposit a small percentage of your wages. Despite FUTA being a federal tax, the money paid to unemployed workers is largely managed by individual states.
The benefits that unemployed workers receive are called unemployment benefits, unemployment insurance or simply UI. These UI payments are intended to help the unemployed survive while looking for work. Receiving pay, such as money earned as an independent contractor, renders you ineligible for UI benefits.
A 1935 agreement between the federal government and state governments created the UI program. The program required employers to contribute a small percentage of wages as federal and state taxes. The federal unemployment tax share is 6 percent of an employee's wages up to $7,000 in a calendar year.; the state unemployment tax rate varies.
Advertisement Article continues below this adWhen an employer pays the unemployment insurance taxes in a timely manner, they get a break that can be up to 5.4 percent of the 6 percent federal tax. This leaves employers to pay less than 1 percent of employee wages to the federal unemployment insurance fund.
The IRS has rules about who they consider to be an employee versus a contractor. Workers who are considered employees of a company are paid a regular hourly, monthly or annual wage rate. An although it's not always a law, employees may receive such benefits as paid time off, health insurance, disability and life insurance, parking and even free coffee and sodas. The rules vary on whether an employer must provide health coverage, and during a national emergency such as a pandemic, some employers may be required to provide paid sick leave to their employees.
Advertisement Article continues below this adEmployees who receive wages and benefits often are referred to as W-2 workers, meaning they receive a W-2 at the end of the calendar year. The IRS W-2 form itemizes earned wages and taxes and other deductions the employer is authorized to take out of the employee's paycheck. In addition, a W-2 employee receives direction from her employer on how to carry out her job duties and what her working hours are, and the employer has general oversight and control of the employee's work.
By contrast, an independent contractor does not receive benefits, he can generally work the hours that he determines are necessary to get the job done, and importantly, the company he works for doesn't deduct taxes from his pay. The IRS's classification rests on a test with three categories, although individual states may have additional rules. The IRS's test looks at the behavioral aspects of the job for which the independent contractor is paid, the financial components of the independent contractor's pay, and the company-contractor relationship.
As you might imagine, the penalties are stiff for the company that misclassifies an employee as an independent contractor because if the IRS discovers the company hasn't paid taxes on your behalf, they could have sticker shock when the IRS gives them a bill for unpaid taxes.
Advertisement Article continues below this adAs an independent contractor, you aren't relieved from the responsibility to pay taxes to the federal and state governments (and, in some cases, the city and local governments). You are responsible for paying self-employment taxes that cover your income tax liability and your unemployment insurance.
The one commonality between work as an independent contractor and that of a W-2 employee is clear – the purpose is to earn money to sustain your quality of life. Regardless of whether you are paid an annual salary and receive benefits or you're paid a lump sum for services rendered, the bottom line is that your pay goes toward paying for housing, food, entertainment, personal items and other normal expenses that everybody incurs.
Because you are earning money, it means you are not eligible to collect unemployment benefits. You are ineligible for unemployment benefits while you are paid as a W-2 employee, and you also are ineligible for unemployment benefits while you are being paid as an independent contractor.
Advertisement Article continues below this adA worker who is laid off or discharged from her job can file for unemployment benefits through the state unemployment benefits office. The state pays you a portion of your wages until you find another job, and there a few conditions on which the state will determine if you qualify for UI benefits.
First, you must attest that you lost your job through no fault of your own, although there are some exceptions to this. For example, the state unemployment office may determine that you are still eligible for benefits if you are a military spouse who must quit to accompany a deployed spouse. Second, you must have wages earned during the last four of five quarters. Finally, you must be willing and able to work. This means you will be asked to prove that you are diligently searching for work.
Additional eligibility requirements may be imposed upon UI applicants. For example, many states require UI benefit applicants to register with the state's job service office, which publishes employment opportunities and provides job counseling services.
Advertisement Article continues below this adUI benefits are paid weekly and are a portion of your previous earnings, so UI benefits are not a true substitute for wages. But receiving benefits can give you some relief and partial income during your job search.
One strict requirement that you are expected to comply with during the time you are receiving UI benefits is reporting any income. This means if you earn any money through temporary work while on unemployment, you must report your earnings to the state. Earnings include work as an independent contractor or an employee, and even if you are collecting a retirement check or severance pay, you must report that to the state that is paying your UI benefits.
Your earnings will be deducted from your weekly UI benefits deposited onto your card. (Many states issue a debit-card-like instrument that you use like cash). For example, if you are entitled to receive $500 a week in UI benefits, and you work as an independent contractor and earn $100, your UI benefits will be reduced by the $100 you earned.
Advertisement Article continues below this adWhile you are not automatically denied UI benefits if you choose to work as an independent contractor, your benefit amount will be reduced by the amount of money you earn as an independent contractor. If you are an independent contractor with a regular gig, and you expect your earnings to regularly be equal to, or more than, your UI benefit amount, it's unlikely that your state will deem you eligible for UI benefits.
If you think that you can earn money as an independent contractor and still collect UI benefits, think again. Your earnings as an independent contractor are reported to the IRS, provided they exceed $600 in a year. Consequently, even if you don't report your earnings to the state when you collect UI benefits, the government has a way to determine if you have been double-dipping. The state and federal governments will be able to tell if you have earned money as an independent contractor at the same time you unlawfully received UI benefits.