FUTA: The Federal Unemployment Tax Act Explained

Do you understand FUTA?

When your business employs people, you are liable for paying employer taxes. These taxes are distinct from taxes paid by employees, such as income tax, which you as the employer withholds from your workers’ paychecks. Instead, employer taxes are a class of payroll tax that is not put on employees to pay, but are paid by you, the business owner and employer.

One of the principal forms of employer taxes small business owners deal with are federal unemployment taxes, which is federal law under the federal unemployment tax act (FUTA).

Read on to find out more about what FUTA is, who pays the FUTA tax and its importance to running your business.

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What Is FUTA?

FUTA is a tax that employers must pay to the federal government. FUTA exists in order to help the government pay for unemployment benefits for workers who have been terminated, except for those terminated because of gross misconduct. You’ll have to pay FUTA taxes if you pay wages of $1,500 or more to your employees in any calendar quarter.

Related: 2020 Business Tax Deadlines You Can’t Miss

FUTA Tax vs. State Unemployment Tax

Take note that the FUTA tax is in addition to any state unemployment insurance your business is required to pay. The FUTA tax provides for paying unemployment compensation on the federal level while state unemployment taxes work towards helping the state pay for unemployment compensation. State unemployment insurance or taxes vary from state to state, so you’ll need to check with the appropriate state authorities to find out your state’s tax rate.

Who Pays FUTA Tax?

You as a small business owner and employer of workers are responsible for paying the federal unemployment tax. Your employees do not pay any FUTA tax or have anything withheld from their paychecks for federal unemployment tax. Instead, the employer pays for all of the FUTA tax. Any business that fits into either of the following criteria need to pay FUTA taxes:

  • Your business paid employees at least $1,500 in wages in a calendar quarter during the current or previous year.
  • Your business employed one or more workers for at least some part of the day during 20 or more different weeks in the current or previous year. This criteria pertains to full-time, part-time and seasonal W-2 employees, but not independent contractors.

The reporting of FUTA tax is annual, but employers actually have to pay the tax in quarterly installments if your FUTA tax liability is more than $500 per quarter. If your FUTA tax liability is $500 or less per quarter, then carry it forward to the next quarter until your cumulative FUTA tax liability is more than $500. Once this occurs, you’ll deposit your FUTA tax for the quarter, with deposits being made through the Electronic Federal Tax Payment System (EFTPS).

See: The Ultimate Guide to Small Business Taxes

What Is the FUTA Tax Rate?

The standard FUTA tax rate employers pay is 6%, according to the IRS. The FUTA tax applies to the first $7,000 in wages you pay to each employee throughout the year. In general, if you paid wages that were subject to state unemployment tax, then you could receive a tax credit of up to 5.4%. If you qualify for the maximum 5.4% tax credit, then your FUTA tax rate is 0.6% after the credit is applied. In order to be entitled to the maximum credit, you need to have paid your state unemployment taxes in full and on time.

The FUTA tax rate hasn’t changed much in recent years. You should stay on top of any possible changes, but FUTA tax rates don’t change as much as interest rates, so you don’t have to be too vigilant. Until June 30, 2011, the federal unemployment tax rate was 6.2%. Beginning on July 1, 2011, the new FUTA tax rate became 6%, which is where it has remained ever since.

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Credit Reduction State

An important note in regards to the FUTA tax involves whether or not the state your business is in is classified as a credit reduction state. In a credit reduction state, the state government has not repaid the federal government for money it borrowed to fund unemployment insurance payments. As a result, in credit reduction states, you cannot get the maximum 5.4% tax credit on FUTA tax. You can find a list of credit reduction states from the U.S. Department of Labor.

How Do You File FUTA Tax Returns?

To pay FUTA taxes, employers must file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. The due date for filing Form 940 is January 31. However, you could have a deadline of February 10 to file if you fulfill certain conditions. Namely, if you’ve deposited all FUTA taxes when they were due on a quarterly basis, then you can take until February 10 to file Form 940.

This is an important point to reiterate: Though the FUTA tax return is filed on an annual basis, if your FUTA tax liability is more than $500 per quarter, then you must deposit payment of federal unemployment tax each quarter. If your FUTA tax liability exceeds $500 for the calendar year, then you need to make at least one quarterly tax payment. Thus, while the FUTA tax is reported annually, employers usually pay the tax throughout the year.

Up Next: 5 Best Free Accounting Software Options for Small Businesses

The Bottom Line

Any business that fulfills one of the basic criteria — either paying employees at least $1,500 in a calendar quarter or employing one or more workers for part of the day for 20 or more different weeks — must pay FUTA tax and file FUTA tax returns. Perhaps the most important point to understand about FUTA taxes is that they are not paid through withholding taxes from your employees’ paychecks. Those types of taxes, such as FICA, Medicare, Social Security and income taxes, come out of your employees’ paychecks. When paying the FUTA tax, you as the employer must pay the tax yourself and, depending on your FUTA tax liability, may have to pay it throughout the year.

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