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Unemployment Benefits for Startups and Entrepreneurs

Unemployment Benefits for Startups and Entrepreneurs

• By Ashe Lockhart
• March 24, 2009

>> A characteristic of the current, dismal economy is that managers, executives and professionals are joining the ranks of the unemployed in significant – perhaps unprecedented – numbers. This is especially true in Charlotte, where banks, financial companies, law firms and service providers are laying off large numbers of highly skilled employees. For many of these displaced managers and professionals, job opportunities in the Charlotte area are slim to none.

Necessity being the mother of invention, it has long been true that entrepreneurship rises when unemployment rises. Displaced employees often see self-employment as the most reliable means of replacing lost income. And these budding entrepreneurs often think of their unemployment benefits as a form of startup capital. So, can a new entrepreneur draw unemployment benefits after starting a business?

Two criteria are immediately apparent regarding eligibility for unemployment benefits: one must be (1) available for employment and (2) actively seeking employment. Superficially, it would seem that, by operating a company and seeking clients, an entrepreneur could say that he is available for employment by a client and that he is actively seeking employment by new clients.

But it’s not quite that simple.

A staff attorney at the North Carolina Employment Security Commission (the “ESC”) stated that if someone receiving unemployment benefits was “so consumed” with the operation of his business that he had really “removed himself from the employment market,” then he would not be considered available for work and, therefore, he would not be eligible for unemployment benefits. On the other hand, she said that if the unemployed person was only preparing to open a business (business planning, looking for an office, shopping for office equipment and supplies, researching how to file documents to organize a business entity, etc.), then, as long as he continued to actively seek employment, he should be considered available for employment and, therefore, eligible for benefits.

At the suggestion of the ESC staff attorney, I reviewed ESC Interpretation 139 (issued in 1956), which indicates that an individual who had been self-employed as a means of supplementing his primary income would be eligible for benefits if he lost his primary employment. But an individual who lost his employment and then became self-employed as a means of replacing his primary employment income would not be eligible for unemployment, even if he is not earning any money at all through his self-employment and even if he states that he is available for and seeking other employment opportunities. Keep in mind that the ESC Interpretation states that “it must be borne in mind that each of these particular cases must be decided on the facts existing in the case.”

In a manner of speaking, the ESC’s determination of eligibility is based on an individual’s intent (although the Interpretation does not express its finding this way). If the new entrepreneur intends that his self-employment income will replace his primary employment income, then he would not be considered available for employment because he has essentially removed himself from the job market, and he would not be eligible for benefits. On the other hand, if the new entrepreneur intends that his self-employment is a means of acquiring “pick-up work” (which is discussed by that name on the ESC website) to help make ends meet during a period of unemployment, and if he is otherwise available for employment and actively seeks employment, then he should continue to be eligible to continue to receive unemployment benefits – but the final determination would be “decided on [all] the facts existing in the case.”

In evaluating “the facts existing in the case,” the ESC would look at activities that indicate intent. For example, the organization of a business entity (whether LLC or corporation) could be an indication that self-employment income was intended to replace primary employment income. Would someone who is just looking for pick-up work go to the trouble of forming a business entity? On the other hand, an attorney might advise an unemployed professional to do pick-up work through a business entity as a means of limiting his personal liability in the event of a dispute with a client or third party, which might be an effective counter-argument to the notion that the only justification for the formation of a business entity would be to provide for self-employment income that is intended to replace primary employment income.

So, self-employment through a business entity is not, by itself, a conclusive determination of one’s intent. But, self-employment through a business entity would create a strong presumption that an individual is not available for work and, therefore, not eligible for unemployment benefits.

Another example of an activity that might indicate intent could be where an unemployed person provides services as an individual subcontractor. In that scenario, the ESC might view the arrangement as indicative of a temporary situation where someone intends to get pick-up work.

But the two scenarios described above do not address the most important and fundamental question – which is whether the recipient of unemployment benefits is honestly and actually available for and actively seeking employment. To put it another way, if someone intends that his self-employment income will replace his primary employment income, then he is not eligible for unemployment benefits – period – regardless of what his self-employment activities indicate outwardly. Furthermore, if he intends that his self-employment income will replace his primary employment income, and if he draws unemployment benefits anyway, then in his weekly reports to the ESC he will have misrepresented that he is available for and actively seeking employment. Such a misrepresentation could be considered fraud – similar to insurance fraud.

Therefore, if a person intends to be available for and actively seek employment while he pursues self-employment pick-up work, then he should keep records of his attempts to secure employment. For example, he should keep (1) a file (electronic files should be fine) of emails and other communications with prospective employers, (2) a record of appointments for face-to-face and telephone interviews and (3) notes of his efforts to secure employment.

Conversely, if someone starts a new venture that is intended to replace primary employment income, then he is not legally eligible to receive the unemployment benefits, and any attempt to obtain unemployment benefits could be viewed as a fraudulent misrepresentation. While I am sure many recession-era entrepreneurs will start businesses that are partially financed by their unemployment benefits, it is a financing method that carries some serious risk.

And note that even if someone intends to be available for and actively seek employment while he pursues self-employment pick-up work and even if he keeps records of his job seeking activities, even then the ESC may still determine that he is not eligible for benefits if the total facts of the case don’t show that he was available for and actively seeking employment. Because, let’s face it, the road to hell is paved with good intentions.

Update: There may be a bright spot for the unemployed who are feeling entrepreneurial. The U.S. Department of Labor offers a program called “Self-Employment Assistance.” “Self-Employment Assistance offers dislocated workers the opportunity for early re-employment. The program is designed to encourage and enable unemployed workers to create their own jobs by starting their own small businesses. Under these programs, States can pay a self-employed allowance, instead of regular unemployment insurance benefits, to help unemployed workers while they are establishing businesses and becoming self-employed” (DOL website). Unfortunately, at the time of this writing, North Carolina has not established a Self-Employment Assistance program. “[T]o date, Delaware, Maine, Maryland, New Jersey, New York, Oregon and Pennsylvania have Self-Employment Assistance programs” (DOL website).

Update #2: My understanding is that this article (in memorandum form) landed on Governor Beverly Perdue’s desk in 2009. She directed North Carolina’s Employment Security Commission (“ESC”) to implement a Self-Employment Assistance Program. I believe the initiative went to a planning committee within the ESC, some recommendations were made, a “program” of some kind was adopted, but it was not publicly announced out of concern that it would be subject to considerable abuse at a time when the ESC’s resources were already under unprecedented strain and the ESC did not have the ability to properly establish the program or monitor participants.

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Ashe Lockhart – Principal

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