Summary: The Federal Unemployment Tax Act (FUTA) regulates contributions from employers to employee unemployment benefits.
If you’re an employee, you might be wondering about the deductions on your paycheck and which taxes apply to you. If you’re an employer, on the other hand, you need to know which taxes to deduct from your employees’ salaries and which you need to pay yourself.
The situation can be complex, but thankfully, the FUTA tax isn’t as complicated as most others. This article will take you through the background of FUTA, explain who it applies to, and show you how to calculate this tax if you’re an employer.
What is FUTA?
The name FUTA is an acronym that stands for the Federal Unemployment Tax Act, also known as Chapter 23 of the US Internal Revenue Code. The FUTA sets out a federal unemployment tax which must be paid by nearly all employers and is based on the earnings of their employees.
This tax must be paid to the Internal Revenue Service either quarterly or annually. The revenue collected from FUTA tax payments is used to provide unemployment insurance benefits and fund job service programs in every state.
FUTA Tax Rate
The FUTA tax has been set at 6.0% of employees’ earnings since it was reduced from 6.2% in July 2011. This is a flat tax rate across the board for all employers in the US except for those that are exempt. The FUTA tax only applies to employers. No FUTA tax may be withheld from employees’ wages.
FUTA Wage-Base Limit
It’s also important to understand that the FUTA tax is not levied on all of an employee’s income for the year. Instead, this tax has a wage-base limit of $7,000. Earnings under this limit can be taxed, and earnings past this limit are not liable to be taxed.
This means that an employer won’t pay more than 6.0% on anything more than an employee’s first $7,000 of annual earnings, or a maximum of ($7,000 x 6.0% =) $420 per year. However, this figure can be greatly reduced through tax credits.
FUTA Tax Credit
Employers can obtain FUTA tax credits of up to 90% by simply paying their state unemployment insurance taxes correctly and on time and filing their FUTA tax returns on time to the IRS. This means that employers can actually be liable for paying as little as 0.60% FUTA tax for their employees.
Therefore, if an employer receives the full FUTA tax credit of 90%, they would only have to pay a maximum of ($420 x 10% =) $42/year per employee. Obviously, most employers are encouraged to comply with state and federal unemployment insurance tax filing rules and deadlines to obtain these significant reductions.
FUTA vs SUTA: What’s the Difference?
At this point, it’s important to clarify the difference between FUTA tax and SUTA (state unemployment tax act) taxes. These taxes are related but also different in several important regards. The FUTA is a federal law that does a few important things.
First, it defines a flat federal unemployment insurance tax of 6.0% of employee wages for all employers. Second, it defines a tax credit based on the payment of state unemployment insurance taxes (SUTA taxes). Third, it sets minimum contribution amounts that states can collect.
In contrast, there is actually no single piece of law called the “State Unemployment Tax Act”. Instead, SUTA refers to all of the acts passed by the 50 states and Washington, D.C. According to the FUTA, these state laws must be approved by the Secretary of Labor.
States can and do set their SUTA tax rates based largely on the experience of the employer, how many layoffs the employer has made, and any delinquency in tax payments. These rates usually range between 1-10%.
States can also set their own wage-base limits but they must be equal to or greater than the federal limit of $7,000. This is done to ensure that enough income is generated by the taxes for each state’s unemployment benefits liability. If a state doesn’t take in enough to pay out all benefits, it may take a loan from the FUTA taxes collected federally, though this may reduce the potential FUTA tax credit available to employers in that state.
To summarize, SUTA taxes are unemployment taxes collected by and with rates set by individual states. FUTA taxes are paid to the IRS, but can be greatly reduced if employers pay their SUTA taxes on time.
Calculating FUTA Taxes
While other taxes can be mindbending and may require a tax specialist to calculate, the FUTA tax is luckily one tax that is easy to work out on your own. If you’re an employee, you can even skip this calculation entirely since you aren’t liable for FUTA tax, and it cannot be deducted from your paycheck.
For employers, you need to contribute FUTA taxes based on 6.0% of the first $7,000 in pre-tax wages you pay your employees. You need to add up these amounts and remit them to the IRS. Let’s look at an example of a small employer to illustrate how these calculations really work:
Example FUTA tax calculation
Employer A has three employees, Employees X, Y, and Z.
- Employee X works part-time at the federal minimum wage level and earns $3000 in the first quarter of the year.
- Employee Y earns $10/hour, works full time, and earns $5,400 in the first quarter (three months).
- Employee Z is a manager who earns a salary of $4,500/month. Therefore, Employee Z earns $13,500 in the first quarter. However, these earnings exceed the wage-base limit, so FUTA is calculated on only $7,000.
Employer A’s calculation for Q1 FUTA taxes would be as follows:
Q1 FUTA liability = (Employee X’s Q1 earnings x 6.0%) + (Employee Y’s Q1 earnings x 6.0%) + (Employee Z’s Q1 earnings up to wage-base limit) x 6.0%
= ($3000 x 0.06) + ($5,400 x 0.06) + ($7,000 x 0.06)
= $180 + $324 + $420
= $924
We can see that Employer A’s total FUTA tax liability is $924 for the first quarter of the year. In Q2, Employer A will pay less because they will no longer need to contribute for Employee Z, and in Q3, they’ll only need to make contributions for Employee X.
Remember the tax credit!
Employer A is liable to pay $420 in contributions for each of these employees for a total of $1,260. However, if they receive the full tax credit of 90%, they’d only need to pay $126 in FUTA taxes for the year.
How Is the FUTA Credit Assessed?
With a possible 90% in savings, all employers want to know how they can obtain tax credits for their FUTA taxes. There are two conditions to meet for FUTA credits:
Condition 1: File on time
We’ve already seen the first condition that helps them achieve this credit – they need to file and pay their state unemployment insurance (SUI or SUTA) taxes correctly and on time, plus file their FUTA tax return correctly and on time. Even if they make mistakes on these filings, they may be able to correct them on time if they’ve filed early and therefore still meet this condition.
Condition 2: Don’t be registered in a credit-reduction state
Unfortunately, the second condition is largely out of the hands of employers. If their businesses are registered in states that have taken loans from the federal government to pay for unemployment benefits, the federal government will recoup on these loans by either reducing or completely eliminating the FUTA credit possible for employers in that state.
While it’s not normally practical for employers to pick up and move states, they can hire intelligently. If they hire remote workers out of state, they have to pay contributions at the rates attributed to the states where those employees work. Thus, they can avoid hiring in credit-reduction states to help reduce their FUTA tax liability.
How to File FUTA Taxes
Employers are required to calculate their own FUTA tax liability and report it to the IRS using Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. Employers can remit their FUTA taxes quarterly or annually, according to this schedule:
| Q1 Deadline | April 30 |
| Q2 Deadline | July 31 |
| Q3 Deadline | October 31 |
| Q4 and Annual Deadline | January 31 |
If a company owes at least $500 in FUTA taxes for the year, however, it must make at least one quarterly payment. If its quarterly liability is less than $500, though, it can roll this amount over to be paid in the next quarter.
FUTA Taxes Summarized
FUTA taxes are unemployment insurance taxes paid to the federal government. They are assessed at 6.0% of the first $7,000 each employee earns and are only paid by employers, not employees. To help reduce your company’s FUTA tax liability, pay your SUTA taxes correctly and on time, and you can be eligible for a FUTA tax credit of up to 90%.
FAQs
These taxes are entirely separate and different. The FUTA is an unemployment insurance tax and is only paid by employers. FICA stands for Federal Insurance Contribution Act and represents Social Security and Medicare taxes that are shared equally by employees and employers.
Yes, paying your state unemployment insurance taxes doesn’t mean you aren’t liable to pay FUTA taxes as well. If you pay them on time and correctly, however, you may receive a sizeable FUTA credit.