Each state sets the rules for its own unemployment insurance program within federal guidelines. Although there is some variation regarding specific requirements and benefits across states, there are a few basic realities that hold true everywhere. One of the most important is that an employer, such as an S corporation, has to have paid into the unemployment insurance system on behalf of its employees for its employees to be eligible to receive benefits.
The IRS requires all corporations, including S corporations, to have at least one employee. In cases of corporations owned by a single shareholder or small groups of shareholders, it can be the case that a shareholder is an owner and an employee. The IRS has officially stated that shareholders who work for S corporations, even if the shareholder is the only owner or worker, are considered employees for purposes of the Federal Unemployment Tax Act. This means that a shareholder can be on the payroll, and if he is, the S corporation must pay unemployment insurance tax on his behalf.
Theoretically, then, if you are on the S corporation's payroll and unemployment insurance was paid on your behalf, you can apply for unemployment.
Proper Payroll Processing
It is not enough to simply be on the S corporation's payroll to collect unemployment. Many small corporations do not run their payroll properly. Some distribute what is called a payroll, but it doesn't include payment of required employment taxes. To establish your eligibility for unemployment as an S corporation shareholder and employee, you should check your pay stub and see if an amount for unemployment insurance was deducted. Alternatively, check with the company's payroll processor.
Actively Seeking Work
Although an S corporation shareholder/employee is technically eligible for unemployment, most will fail the second threshold test: States require unemployment-benefits recipients to be "actively seeking work." Courts have held that owners of S corporations who keep the corporation viable, even though it has no revenue, are not actively seeking work because new work can come into the corporation at any time. In other words, states often think that S corporation owners will close down the business simply to wait out a poor business cycle. To collect unemployment, you will have to prove to the state that the S corporation is no longer viable, and you are conducting a job search.
At certain times, the federal government allows entrepreneurs to collect unemployment while building their businesses. The federal government also occasionally implements special programs for self-employed veterans. There are no hard-and-fast rules about eligibility for unemployment benefits because of these periodic initiatives. It is always best to simply apply to your state unemployment agency and let it decide your case on an individual basis, under whichever policies may be in effect at that time.