New Year Brings Higher Taxes on California Employees and Employers

Gina Rodriquez

By Gina Rodriquez, Principal, Ryan

California’s state disability insurance (SDI) program — funded by a tax paid by employees through wage withholding —increased in two ways on January 1. First, the SDI rate increased from 0.9 percent in 2023 to 1.1 percent in 2024; and second, the taxable wage cap ($153,164 in 2023) was eliminated as a result of SB 951 (Ch. 22-878).

Governor Gavin Newsom’s signature of SB 951 and the elimination of the SDI wage cap is reminiscent of former Governor Gray Davis’ signature of AB 429 (Ch. 01-111). SB 951 quietly and permanently increased taxes on many California employees; and AB 429 quietly and permanently increased taxes on California employers by repealing the 2002 sunset date of the “temporary” Employment Training Tax (ETT), thus making the ETT a permanent tax increase on employers. (Tidbit: Davis was Governor Jerry Brown’s chief of staff from 1975 to 1981 when Brown served as California’s 34th governor, and Newsom was California’s lieutenant governor from 2011 to 2019, when Brown served as California’s 39th governor.)

SDI is financed solely by worker contributions through payroll deductions and must have an adequate reserve rate, which is why the SDI rate is subject to change annually – it can go up or down or stay the same.

An employee’s SDI withholding applies to all taxable wages, at a rate of 1.1 percent in 2024. “All” means all taxable wages from every employer that an employee has during the year. For example, if an employee earned $90,000 from one job and $80,000 from a second job in 2023, that employee paid the maximum SDI of $1,378.48 ($153,164 x 0.9 percent). The same employee earning the same amount in 2024 will pay $1,870 ($170,000 x 1.1 percent) in SDI. This is a $491.52 tax increase, or 36 percent more, from the prior year.

Corporate officers may be in for sticker shock: A CEO of a corporation who earned $2 million in 2023 paid the maximum SDI of $1,378.48 ($153,164 x 0.9 percent). That same CEO earning the same amount in 2024 will pay $22,000 ($2 million x 1.1 percent) in SDI. This is $20,621.52 more than in the prior year, a whopping 1,496 percent increase in tax.

Is there a way out of this tax increase for employees? Fortunately, the answer is “yes,” but employers will need to get their employee benefits professionals engaged.

Employers may 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 plan (VP), a legal alternative to mandatory SDI. Both SDI and VP provide short-term wage replacement disability insurance and family leave benefits. A VP may allow valuable employees to increase their take-home pay and allow employers to remain competitive in the labor market.

To offer a VP, employers first must apply and get approval from the California Employment Development Department (EDD). Employers may establish a VP with approval from a majority of their employees and must provide the EDD with proof of the approval. A VP still may be funded by employee contributions through wage withholding, which an employer must deposit into a trust fund. A VP 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 VP 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 likely 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, it might be time to rethink it. Further, all shareholders – not just sole shareholders – may 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 are facing an employment tax increase in 2024 in the form of higher FUTA taxes. FUTA stands for Federal Unemployment Tax Act, a federal employment tax paid solely by employers. California still owes about $19.7 billion to the federal government in unemployment insurance (UI) loans resulting from the pandemic (and perhaps some fraud) and has defaulted. This makes California what is known as a “credit reduction state.”

The initial FUTA increase started in 2022, and California is in its second year as a credit reduction state. Only California, New York ($7 billion owed), and the U.S. Virgin Islands ($87.5 million owed) were credit reduction states for 2023. California’s elected officials have not stepped in to relieve employers, so employers are responsible for paying off the loan. Note: At press time, California employers were not subject to a “surtax” to repay the interest on the federal loan, although that has been proposed in prior years. The interest payment for 2024 is $331 million, and while there is no “surtax,” Newsom’s proposed 2024-25 budget released January 10 calls for one-time funding of $231 million from the state’s general fund. The other $100 million will come from the state’s Employment Training Fund, which is paid exclusively by employers via the 0.1 percent Employment Training Tax (ETT) on the first $7,000 of wages per year.

The standard FUTA rate is 6.0 percent, but generally employers with a good claim rate history receive a 5.4 percent credit, reducing the FUTA rate to 0.6 percent, paid each January with employers’ federal Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return.” For credit reduction states, generally, the FUTA credit is reduced by 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 in credit reduction states. It took California employers seven years to pay off the last federal UI loan, which was fully repaid in 2018.

For the 2023 federal Form 940 that is due at the end of this month, the FUTA credit will be reduced by 0.6 percent to 4.8 percent, making the FUTA rate 1.2 percent (6 percent minus 4.8 percent) for 2023. This results in a total FUTA liability of $84 per employee ($7,000 wage cap x 1.2 percent) for 2023, which is an additional $42 ($7,000 wage cap x 0.6 percent) per employee over 2021 (recall that 2022 was the first credit reduction year).

As an example, 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. The employer’s FUTA liability was $4,200 for all employees payable in January 2022. However, for 2023, California’s FUTA credit reduction increases the FUTA rate to 1.2 percent, or $84 ($7,000 x 1.2 percent) per employee. This results in a FUTA liability of $8,400 for all employees, payable in January 2024. This is double the amount of FUTA paid for 2021.

Happy new year from California!