Most businesses know that high labor turnover is expensive.  Hiring and training employee replacements is costly and time consuming.  Productivity drops because new employees are inefficient until they learn how to do their jobs properly.

However, one cost that employers are often unaware of is increased payroll taxes.  When a new employee is hired, social security and federal and state unemployment taxes are paid on a new wage base ($90,000 FOR 2005), the wage base for federal unemployment taxes is $7,000.

As an example of how these additional payroll taxes can add up.  Assume that you are an employer who pays state unemployment taxes at the usual rate.  At the end of the first six months of the year, you replace a top management employee who earns $180,000 a year.  Despite the fact that you’ve already paid the maximum social security and state unemployment taxes for the original employee, you now have to pay these same taxes for the replacement employee.  The net effect is that you will pay payroll taxes for two employees earning $90,000 for the year rather than the maximum social security and state unemployment tax for the first $90,000 earned by one employee.  Your total payroll taxes will now be a least $13,770 instead of almost half of what you would pay for one employee.

While the additional payroll taxes are not as substantial for lower paid employees, they can still represent a sizable cost increase, particularly if you have a large work force.

In addition, most states determine an employer’s unemployment tax rate by the employer’s labor force turnover record.  High turnover can result in a substantial increase in an employer’s tax rate as well as in worker’s compensation premiums and certain other employee plan payments.

Although the tax cost of high labor turnover often goes unnoticed, it can add up to a substantial sum of money.