By Gina Rodriquez
Principal, Advocacy Services Practice
Ryan, LLC
Just as they did at the beginning of 2024, California employers and employees experienced yet another tax increase starting January 1, 2025. In the famous words of Yogi Berra, “It’s déjà vu all over again.”
California’s state disability insurance (SDI) program, funded by a tax paid by employees through wage withholding, increased in two ways January 1, 2024. First, the SDI rate increased from 0.9 percent to 1.1 percent, and second, the taxable wage cap ($153,164 in 2023) was eliminated as a result of SB 951 (Chapter 878, Statutes of 2022).
Starting January 1, 2025, however, the rate increased again, to 1.2 percent. SDI is required to have an adequate reserve rate, which is why the SDI rate is subject to change annually – it can go up, down, or stay the same (but under Unemployment Insurance Code section 984, the rate may not exceed 1.5 percent or be less than 0.1 percent).
The rate seemingly will continue to increase each year until the Employment Development Department (EDD) thinks there is enough for Paid Family Leave Benefits.
An employee’s SDI withholding applies to all taxable wages from every employer that an employee has during the year, and last year’s removal of the wage cap has a major effect. An employee who earned $90,000 from one job and $80,000 from a second job in 2023 would have paid the maximum SDI of $1,378.48 ($153,164 x 0.9 percent) that year. The same employee earning the same amount in 2025 will pay $2,040 ($170,000 x 1.2 percent) in SDI. This is a $661.52 tax increase, or 48 percent more, from 2023.
Corporate officers may be in for sticker shock. A CEO who earned $2 million in 2023 paid the maximum SDI of $1,378.48, but will pay $24,000 ($2 million x 1.2 percent) in 2025 – a whopping 1,641 percent increase in tax.
Unlike most tax increases, there is a way out of this one, but employers will need to get their employee benefits professionals engaged.
Employers can minimize the SDI tax increase on their employees while potentially offering greater disability insurance. To mitigate the impact of the tax increase on affected employees, employers may consider offering their employees a voluntary disability plan (VDP), a legal alternative to mandatory SDI. Both SDI and VDP provide short-term wage replacement disability insurance and family leave benefits. A VDP may allow valuable employees to increase their take-home pay and allow employers to remain competitive in the labor market.
To offer a VDP, employers must apply and get approval from the EDD. Employers then may establish a VDP with approval from a majority of their employees and must provide the EDD with proof of this approval. Like SDI, a VDP may be funded by employee contributions through wage withholding, which an employer must deposit into a trust fund. A VDP must be offered to all of an employer’s California employees or to all employees at any of the employer’s distinct, separate California establishments.
Further, a VDP must have all of these attributes:
- Offer the same benefits to employees as SDI.
- Provide at least one benefit that is better than SDI.
- Not cost employees more than SDI.
- Be updated to match any increase in benefits that SDI implements from legislation or approved regulations.
For sole shareholders, electing out of the SDI program has always been an option if they buy disability insurance in the private market. Sole shareholders didn’t pay much attention to this option in the past because of the SDI wage cap, but now that the wage cap has been eliminated and the rate has increased, it might be time to rethink it.
Additionally, all shareholders – not just sole shareholders – might want to increase their distributions rather than their wages to mitigate the tax increase, but they would need to ensure it meets the reasonable-compensation test and should check for impacts on any 199A deduction.
Like their California employees, California employers also face an employment tax increase in 2025, in the form of higher FUTA taxes. FUTA (the Federal Unemployment Tax Act) is a federal employment tax paid solely by employers. California owes about $20.9 billion to the federal government in unemployment insurance (UI) loans resulting from the pandemic (and perhaps some fraud) and has defaulted. This makes California a “credit reduction state,” triggering a tax increase on employers.
The initial FUTA increase started in 2022, and California is in its third year as a credit reduction state. Only California, New York ($6.2 billion owed), and the U.S. Virgin Islands ($79.9 million owed) were credit reduction states in 2024.
California’s elected officials have not stepped in to relieve employers, so employers are responsible for paying off the loan. Currently, California employers are not subject to a “surtax” to repay the interest on the federal loan, although that has been proposed in prior years. California’s interest payment on the loan is about $300 million annually.
The standard FUTA rate is 6 percent, but generally employers with a good claim-rate history receive a 5.4 percent credit, reducing the rate to 0.6 percent, paid each January with federal Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return.”
For credit reduction states, the FUTA credit generally is reduced an additional 0.3 percent each year until the federal loan is repaid. From the third year on, there may be additional reductions in the FUTA credit. It took California employers seven years to pay off the last federal UI loan, which was fully repaid in 2018.
For the 2024 federal Form 940 that is due at the end of this month, the FUTA credit will be reduced 0.9 percent to 4.5 percent, making the FUTA rate 1.5 percent (6 percent minus 4.5 percent) for 2024. This results in a total FUTA liability of $105 per employee ($7,000 wage cap x 1.5 percent) for 2024, which is an additional $63 per employee over 2022.
An employer with 100 California employees in 2021 owed a total FUTA liability of $42 ($7,000 x 0.6 percent) per employee without a credit reduction, so the employer’s FUTA liability was $4,200 for all employees payable in January 2022. For the payment due this month, the same employer will have to pay $105 ($7,000 x 1.5 percent) per employee, for a total of $10,500 for all employees – more than double the tax paid three years ago.
Happy New Year from California!