What Is FUTA: An Employer’s Guide

Are you an employer with a reasonable number of employees and want to know about the what is the current FUTA tax rate?  and who is Exempt from FUTA tax? Here is a complete guide for you to understand everything about FUTA.

The Federal Unemployment Tax Act was passed in 1939 in order to raise revenue to administer unemployment insurance and job service programs in every state. The act directs the employers to pay annual or quarterly federal unemployment taxes; they make up a part of what is commonly known as payroll taxes. The funds in the account are used for unemployment compensation payments for those workers who have lost their job under normal circumstances.

Although the tax is based on employees’ wages, it is imposed on employers only, not their employees. As IRS states, a business owes federal unemployment taxes if:

• It had at least one full-time, part-time, or temporary employee for at least some part of a day in any 20 or more different weeks in the current or previous year.
• It paid at least $1,500 in wages during any calendar quarter in the current or previous year. (A calendar quarter is January through March, April through June, July through September, and October through December).

If you are entitled to pay FUTA taxes but know little about the act, this article will help you know what is FUTA, how it works for all kinds of business, and how much you are supposed to pay in the current year.

What is FUTA?

What is the FUTA tax, or the Federal Unemployment Tax Act, is a policy craft in 1983, to help states to pay workers, whose contracts have been terminate. The policy, however, is not applicable for those workers who have lost their job due to grave misconduct. Employers who pay wages more than $1,500 are subject to pay this tax annually to the federal government. The tax is in addition to any state unemployment insurance you may owe.

Employees do not have to pay any FUTA tax, and their paychecks get subtracted. The tax is applied to the first $7,000 of wages to the employees by the employers. Anything beyond this threshold, would not be taxable. There is no FUTA tax on self-employed individuals, however. Hence, if you are a partner, you won’t be paying any distributive share of partnership profit. Also, if you extend working with independent contractors, you don’t pay FUTA on payments to them.

What does FUTA stand for?

Meaning of FUTA is “federal unemployment tax act”.

Basic FUTA rate

The basic FUTA rate is 6% which gets reduce to 5.4% if you receive a credit for state unemployment tax. Applying this tax rate to the first $7,000 of wages for each employee would result in $42 per employee. There has been a 0.2% surtax in effect from 1983 which later was extend multiple times and finally ended in 2007. Many employers are subject to pay both Federal and state unemployment tax.

If a state has not repay borrowing from the federal government, to cover its unemployment benefits liability, that state is label as a “credit reduction state” which means that the amount of credit for state unemployment tax is reduce and the FUTA rate is substantially increase. This designation of credit reduction states was make by the Department of Labor.

While different states might exercise their own regulations regarding unemployment benefits, sometimes they lack the adequate funds to cover unemployment compensation. In the event that the state would borrow money from the federal government, the FUTA fund tax can supply financial support for unemployment benefits. Unlike taxes under Federal Insurance Contribution Act (FICA), employers pay the tax rather than employees.

Any employers who have hired one or more employees who work at least part of a day, or 20 hours a week, are obliged to pay FUTA tax. Even with this understanding of FUTA tax definition, you should consider these points.

how it can impact a small business:

• FUTA tax credit: If you pay State Unemployment Tax Act (SUTA) on time, you are eligible for FUTA tax credit which can be up to 5.4%. That means you are liable to pay only 0.6% FUTA tax.
• The magic number is $7,000: If you are required to pay FUTA based on the mentioned criteria, the amount you are responsible to pay equals 6% of the $7,000 your employee makes each year. As you pay this, anything that is earned beyond this limit is not subject to FUTA taxes.
• Payments are due quarterly: It’s common to pay taxes quarterly in the tax world. The same applies to FUTA which has deadlines for April 30th, July 31st, October 31st, and January 31st. Failing to pay taxes on time would cause you to pay penalties between 2% and 15%.
• Employees do not pay FUTA: There are some payroll taxes that employees contribute to such as Social Security and Medicare taxes, but FUTA is one whose sole responsibility falls on the employers.

FUTA and FICA

FUTA is designed to benefit unemployed employees which are being pay by the employers to the federal government. FICA, on the other hand, is a separate tax that is pay by both employers and employees to provide Social Security and Medicare benefits. The FICA tax is 6.2% on taxable compensation up to a fixed amount annually for instance $137,700 in 2020 for the Social Security portion and 1.45% of taxable compensation for the Medicare portion.

FICA contributions are mandatory and its rates are set annually, although not necessarily change every year. As the rates remained the same between 2020 and 2022. The amount of the FICA tax is directly proportional to the income of the employee: the higher the income, the higher the FICA payment. However, for Social Security contributions, there is a maximum wage limit, beyond that, no contributions are levied on additional income.

There is no maximum to the Medicare contribution however, there is an additional 0.9% tax on wages over $200,000 for individuals and $250,000 for a married couple filing jointly, paid by employees. The federal government withholds Social Security taxes up to the annual wage base, which was set at $142, 800 in 2021 and $147,000 in 2022. In sum, the Additional Medicare Tax is 2.35% (1.45% and 0.9%).

The employer and employee pay the same price, for example, if an employee earns $50,000, the employer’s FICA tax is $3,825 (6.2% of $50,000+1.45% of $50,000). The employee pays the same $3,825, which is withheld from their paycheck.

Credit reduction

If a particular state has an outstanding advance commonly called a “loan”, the credit against the federal government gets reduced. When states lack funds to pay unemployment insurance, they may get loans from the federal government.

To make sure that these loans are repay by the states and in accordance with Title XII of the Social Security Act, the federal government is entitle to recover them by reducing the FUTA credit it gives to employers, which equals to an overall increase in the FUTA tax. When a state owes an outstanding loan balance on January 1 for two consecutive years, and the full amount of the loan is not repay by November 10 of the second year, the FUTA credit is reduce until the loan is repay.

This process is called FUTA credit reduction and was launch as an involuntary repayment mechanism. The reduction schedule is 0.3% for the first year and an additional 0.3% for the succeeding years until the loan is repay. For the third year onward, there may be additional reduction introduce in the FUTA tax credit, commonly known as “add-ons”.

For instance, for taxable years 2012 and 2013, the Virgin Islands had a 2.7% “add-on” when its tax rate on total wages was below a national minimum. In the third year, Connecticut had a “BCR add-on” when its tax rate on the taxable portion of covered wages in the previous calendar year was less than the 5-year benefit-cost ratio that was applicable for the taxable ratio.

Based on their loan status in 2016, both Virgin Island and California were the only two jurisdictions that received reduced FUTA credit for the taxable year 2016. Employers in these states paid extra FUTA taxes.

FUTA tax and general taxes comparison table

Below is the list of general taxes and FUTA taxes along with the added conditions:

Exempt wages from FUTA

The following list of wages are exempt from the Federal Unemployment Tax Act:

• Wages paid by a foreign government or international organization
• Wages for the services performed outside of the United States
• Wages paid by a parent to their child under age 21, paid by a child to a parent, and paid by one spouse to the other
• Wages paid by a hospital to the interns’
• Wages paid by a state to local government or by the United States federal government
• Wages paid by a school to the student of a school
• Wages paid to a newspaper carrier under the age of 18
• Wages paid to a deceased employee or a deceased employee’s estate in any year of the employee’s death
• Wages paid by an organized seasonal camp to a full-time student who worked fewer than 13 calendar weeks during the calendar year
• Wages paid by 501 (c)(3) organizations

Who has to pay FUTA and SUTA taxes?

Both FUTA and SUTA taxes are being paid by employers under whom employers work a minimum of 20 to 30 hours a week. These taxes are also called payroll taxes. Hence, if your business has no employers or you are a self-employed individual, you are not subject to pay federal or state unemployment taxes. Contrary, any business that falls in either of these categories must pay FUTA taxes:

• You hire one or more employees who work for at least some part of the day or 20 hours a week or more different weeks this year or the previous year at minimum. This refers to full-time or part-time, and seasonal W-2 employees, but not independent contractors.
• You pay employees $1,500in wages in a calendar quarter during the current or previous year.

Generally, you don’t have to pay FUTA or SUTA taxes on your income, unless your business falls in the category of a corporation. Also, if you have a family-run business or partnership, your child’s wages, if he is 21 or older, and spouse wages do not count for FUTA and SUTA purposes.

You can contact your state’s unemployment tax agency to know if you have to pay SUTA taxes. Finally, certain types of businesses such as religious institutions, nonprofits, and educational institutions are exempt from these taxes.

What is the FUTA tax rate

Being an eligible employer to pay federal unemployment tax rate, the very first thing you would probably want to know is how much you have to pay. Overall, both FUTA and SUTA taxes are calculate base on the number of wages an employer is extending to his employees, up to a certain limit. The business tax rates and wage limits do not remain static and keep on changing.

On this account, Jennifer Affrunti, a CPA and controller at Nussbaum Berg Klein & Wolpow PC, says that “it is worth noting that wage base and rates for FUTA have not increased, for quite a while. While there is nothing definitive right now, there are discussions in the work that would reinstate higher taxes sometimes in the future.

How much exactly are the FUTA tax rates?

So how much exactly are the FUTA tax rates? The FUTA tax rate in 2019, which remain the same in 2020 was 6% on the first $7,000 of wages that were being pay to the employee during the calendar year. Beyond $7,000 in annual wages, you are not entitle to pay federal unemployment taxes. So, what is futa on my paycheck is 6% on $7000 of wages.

Therefore, to calculate FUTA taxes for an employee who has receive $6,000 in annual wages, you would simply multiply $6,000 by 0.06 which gives $360. For an employee who receives more than $7,000 in annual wages, on the other hand, you would perform the same calculation on the first $7,000 by 0.07 to get $420, the maximum you have to pay for any single employee for FUTA tax.

It is important in this regard, that not all payments you make to employees are include in the FUTA tax. Generally, gross wages, most fringe benefits, and some employer contributions to employee retirement plans are include in this calculation which total is subject to the 6% of the FUTA tax rate.

This being say, the federal government also grants a business tax credit of 5.4% of business owners who have pay their state unemployment taxes on time, this effectively reduces the FUTA tax rate down to 0.6%.

Unfortunately, if your business is in a credit reduction state, you lose the chance to claim 5.4% credit. Note that credit reduction states are states that have failed to repay the federal government for the money that they borrowed to fund unemployment insurance payments.

When and how to file and pay FUTA taxes?

The IRS Form 940 is to be fill by the employers to start the process of filing FUTA taxes. The form is to be fill by 1st January of each year, or the next Monday if this date falls on a weekend. Remember that the date for filing the form the day taxes are being pay are different. If you regularly pay your taxes on time, the date for filing the form gets extend to the second Monday in February.

With FUTA taxes, this is the thing that you would be paying taxes on a quarterly basis, even though you fill the Form 940 once a year. Affrunti says, “A common mistake is made thinking that FUTA requires an annual filing. Employers sometimes mistake their payment liability and may assume that payment is always due with the filing. Once an employer’s liability reaches $500, however, they are required to submit the tax on a quarterly basis. If you do not pay on time, you can incur penalties”.

Even if your tax liability is more than $500, you need to pay the amount on a quarterly basis, but in case it is lower than $500, then roll that amount to the next quarter. Once the total FUTA liability in a quarter reaches the limit of $500, then you need to deposit the payment no later than the last day of the following quarter. But if the day you need to deposit the tax falls on weekends or some holiday, you can wait for the following business day.

Here are the quarterly dates for depositing the FUTA taxes:

• First quarter (January 1 to March 31): Payment due by April 30
• Second quarter (April 1 to June 30): Payment due by July 31
• Third quarter (July 1 to September 30): Payment due by October 31
• Fourth quarter (October 1 to December 31): Payment due by January 30

In case your tax liability is under $500 for the year, you don’t have to deposit the payment quarterly but you can either choose to be a quarterly depositor or you can pay your taxes once a year when you file Form 940. While busy filing the FUTA tax form, you need to remember the dates for SUTA tax filing whose deadlines might differ from the federal deadlines. For that, you need to contact your state unemployment agency to learn the details of your business.

An electronic funds transfer or EFT is being use to process the federal tax deposits. For that, the Electronic Federal Tax Payment System can be use at eftps.gov. You would be automatically enroll in the system when you apply for EIN if you are a new business owner, and you may have receive instructions to activate your account in the envelope when you would have got your EIN. Other businesses, however, need to enroll through the website.

Calculating your FUTA tax liability amount, and paying it on time would keep you in good standing with the IRS as no business would want to pay penalties, fees, and interests on late tax payments. Paying taxes on time would provide added benefits to your business as a whole.

Tips to manage FUTA and SUTA taxes

Being an employer, paying FUTA and SUTA taxes are unavoidable tasks. But compared to other payroll taxes, such as FICA taxes and other income taxes, FUTA taxes are bearable and easily payable. You can manage the taxes by using these practices to keep the amount as low as possible.

File your taxes on time

This might sound cliche to you, but having to manage other taxes and business responsibilities, you might miss out on major deadlines for your FUTA or SUTA taxes. So, catching the upcoming deadlines is important, whether you pay your taxes on an annual or quarterly basis. As if you fail to meet the deadlines and pay the taxes on time, the IRS and your state unemployment agency will charge fees.

In fact, the IRS penalties for late payment of taxes range from 2% to 25% depending on how late you are in paying your dues. These charges can easily be avoid if the upcoming deadlines are make on time. Also, adhering to the deadlines and not waiting for the last minute would give you a good margin to fill out your Form 940 properly and avoid errors, by which you will save the time, effort, and money for having to amend any mistakes.

Respond to unemployment claims

The SUTA tax rate is based on the company’s employment history and the companies having high levels of turnover and large numbers of unemployment claims have to pay higher SUTA taxes. So, in order to keep the tax rates down, companies should respond to unemployment claims as soon as they are file. The claims should not be avoid thinking they are not legitimate. Most of the claims are legitimate and one should respond if there appear to be any claims.

Most employers are provided the opportunity to appeal a claim for unemployment compensation by most states. If anything questionable appears like the employee provides the wrong termination date or states the wrong salary, you should respond in your first priority. Blocking fraudulent unemployment claims would also be a way to keep your SUTA rates low.

Keep turnover low

Remember that both FUTA and SUTA taxes are calculate from a wage base. The wage base for FUTA tax is $7,000 which means you only have to pay FUTA taxes on the first $7,000 of an employee’s annual wages, which also means that every time you hire a new employee, the wage base kicks in anew.

For instance, you pay $40,000 to a customer service associate per year. If that person has been serving in the service for the last year, you only have to pay $42 in federal unemployment taxes for that employee (if you qualify for the maximum tax credit) plus additional state taxes. Contrarily, if you’ve hire four different people for that role in the last year, then you are charge quadruple of your FUTA tax burden; $168.

So, the smart decision for an employer is to keep your employee turnover as low as possible. If your budget is tight, you can try to avoid layoffs by increasing cross-departmental transfers. Following these strategies would help your FUTA and SUTA taxes low.

Use a payroll service or PEO

If all of your employees are living in the state where your business is located. Paying your FUTA and SUTA taxes would be an easy task. The process gets a little hard with multiple locations, remote employees, or employees who work in one state while living in another. If your case is the same, using a small business payroll service or a professional employer organization (PEO) can help simplify things

A payroll will automate the process; with a few clicks and some information about your workforce. They’ll make sure to file the right forms on your company’s behalf and send the right payments. There is an additional step with PEOs. They pool together many small businesses and act as a co-employer to everyone who works in those businesses.

Some states employ the experience rating of the PEO, rather than the actual business, to calculate SUTA rates. For a business that has experienced a lot of turnovers. This can be very helpful. In this way, you essentially get to fetch off the larger size and lower turnover rate of the professional employer organization, resulting in lower SUTA rates.

FAQ’s about Federal Unemployment Tax Act (FUTA)

Who pays unemployment tax

FUTA definition is a federal tax that is impose on employers in order to provide funding for unemployment benefits. This tax is typically pass on to the employees in the form of lower wages, and it can be use to finance both state and federal unemployment programs. So, who pays unemployment taxes, these taxes are paid by businesses with more than $500 in payroll.

Federal unemployment insurance

It is a federal law that imposes a tax on employers in order to provide unemployment compensation to workers who have lost their jobs. Federal unemployment withholding is calculate as a percentage of an employer’s total wages paid to employees, and is typically 1.0% of those wages.

FUTA tax rate 2020

Federal unemployment tax rate 2020 is a payroll tax impose by the federal government on employers. The tax is use to fund unemployment compensation programs for workers who lose their jobs. The tax rate is 6% of an employee’s wages, up to a maximum of $7,000. Employers are responsible for paying the tax, and they can pass the cost on to employees in the tax rate 2020.

Who Needs to Pay FUTA Tax

If you have employees working in the United States, you will need to pay FUTA tax. This includes full-time, part-time and seasonal workers. You will also need to pay FUTA tax if you have workers who are based outside of the US but who are performing work within the country.

FUTA Reporting Requirements

All employers who are subject to the Federal Unemployment Tax Act (FUTA) must file an annual report. This report determines the amount of FUTA tax that the employer owes.

The information that must be reported on the annual report includes:

• The name and address of the employer
• The Employer

How to Pay and Report FUTA Taxes

Federal unemployment tax definition, with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. FUTA is a federal tax that all employers must pay. The current FUTA tax rate is 6.0% on the first $7,000 of wages pay to each employee in a year. Employers can get a credit against the FUTA tax for any state unemployment taxes they pay. The maximum credit is 5.4%, resulting in a net FUTA tax of 0.6%.

Employers must report and pay their FUTA taxes quarterly. They can do this online, by phone, or by mail.

How to calculate FUTA Tax

FUTA, or the Federal Unemployment Tax Act, is a payroll tax that all employers must pay. The FUTA tax funds the FUI taxes program, which provides temporary financial assistance to workers who have lost their jobs. To calculate your FUTA tax liability, you will need to first determine your gross payroll for the year. This is the total amount of wages and salaries you paid to all employees during the year. Once you have determined your gross payroll, you will multiply this amount by the FUTA tax rate. The current FUTA tax rate is 6.0%.

Conclusion

So what does FUTA mean, Federal Unemployment Tax Act (FUTA) is a federal law that requires employers to pay annually or quarterly to fund unemployment benefits for employees who lost their jobs except for some serious mischief. The tax rate for the FUTA tax is fix at 6% of the first $7,000 of wages, though many businesses qualify for a tax credit that lowers it to 0.6% give some conditions.

Most businesses also have to comply with their state’s State Unemployment Tax Act (SUTA), which coordinates with the federal tax. The unemployment tax rate federal is pay by the employers. The revenue that is generate is allocate to state unemployment insurance agencies and use to fund unemployment benefits for people who are out of work.