The tax world is overflowing with funky-sounding acronyms, and FUTA might be the strangest one out there. You may be wondering, What is FUTA tax?
If you’re an employer, you have to know about FUTA tax—because you’ve got to pay it.
Read on to learn more about the tax, the rate, and how to report and deposit it.
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What is FUTA tax?
FUTA tax is a federal payroll tax that funds federal unemployment benefits for displaced workers. FUTA stands for the Federal Unemployment Tax Act.
FUTA taxes fund the federal government’s oversight of each state’s unemployment program, which is funded by a state payroll tax known as SUTA tax.
Technically, FUTA is a payroll tax. But unlike FICA tax, only employers pay FUTA.
Not all employers qualify for FUTA tax. Three tests help determine if you must pay a FUTA tax on employee wages: a general test, a household employers test, and an agricultural employers test. For this article, we’ll focus on the general test.
According to the general test, you must pay FUTA tax on employee wages if:
- You paid wages of $1,500 or more to employees in any calendar quarter during the current or previous year, OR
- You had one or more employees for at least some part of a day in any 20 or more different weeks in the current or previous year.
Make sure to count all full-time, part-time, and temporary employees.
For more information on the household employers test and the agricultural employers test, see IRS Publication 15.
State unemployment tax programs
Each state has its own unemployment tax to fund unemployment benefits. State unemployment taxes go by many names, depending on the state. Terms for state unemployment taxes include SUTA tax, state unemployment insurance, and reemployment tax.
When a state does not have enough money to pay for unemployment benefits, the state can borrow money from the federal government. The money the federal government lends comes from FUTA taxes.
How much is the FUTA tax rate?
The FUTA rate is 6% and only applies to the first $7,000 in wages paid to each employee for the year. This $7,000 is also called the FUTA wage base.
The largest FUTA tax amount you’ll pay per employee is $420 ($7,000 X 0.06). You should go back over your numbers if you pay more than $420.
However, most employers receive a FUTA tax credit that drops the FUTA rate from 6% up to 0.6%.
FUTA tax credit
If you pay wages subject to state unemployment tax, you may be eligible for a FUTA tax credit. The FUTA tax credit can cover up to 5.4% of your FUTA taxable wages when you file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.
Employers with the maximum credit of 5.4% only owe 0.6% (6% – 5.4%) on the first $7,000 of each employee’s wages per year. If you qualify for the maximum tax credit, the most you will pay per employee is $42 ($7,000 x 0.006).
Who’s entitled to the maximum credit? You’re entitled to the FUTA tax credit if you paid your state unemployment taxes in full, on time, and your state isn’t a credit reduction state.
Does your company qualify for the full FUTA tax credit?
Qualifying for the FUTA tax credit depends on how much state unemployment tax (SUTA) you pay relative to your company’s total FUTA-taxable wages. If you don’t meet the minimum SUTA tax paid requirements, your FUTA tax rate may increase, which could result in a larger tax bill at year-end.
One thing the IRS looks at total is FUTA-taxable wages across your business, not just wages subject to SUTA. Your eligibility for the credit can be affected if you have SUTA-exempt employees, or pay less than the IRS expects in SUTA wages.
Here’s how the IRS determines tax credits for FUTA:
- Total FUTA Taxable Wages: The overall wage base subject to FUTA tax.
- Wages Exempt from State Unemployment Tax (SUTA): These are multiplied by 5.4% (.054) to calculate a portion of the reduced credit.
- Additional Credit for Lower SUTA Rates: If the company’s state unemployment rate is below 5.4%, an additional credit may apply based on the difference and SUTA taxable wages.
- Timely Payment of SUTA Taxes: SUTA tax liabilities must have been paid in full and on time to qualify for the credits.
- State Credit Reduction: If the state has a federal loan outstanding, this could influence the total FUTA tax rate.
Based on these answers your FUTA Tax rate could be 0.6% up to 6%.
Let’s run through the FUTA rate calculations of a company with 3 employees, including a SUTA-exempt employee, and NOT in a credit reduction state:
| Employee | SUTA Status | FUTA-Taxable Wages | SUTA Rate | SUTA Tax Paid |
|---|---|---|---|---|
| Alice | Not Exempt | $7,000 | 2.7% | $189 |
| Ben | SUTA Exempt | $7,000 | N/A | $0 |
| Charlie | Not Exempt | $7,000 | 2.7% | $189 |
- Total FUTA-Taxable Wages: $14,000 ($7,000 x 2 Employees)
- Total SUTA Tax Paid: $189 + $189 = $378 paid
- IRS Expected SUTA Payment: $14,000 × 5.4% = $756
- Percentage of SUTA Paid: $378 (actual SUTA tax) ÷ $756 (IRS expected SUTA tax) = 50%
- FUTA Credit Earned for the company: 5.4% × 50% = 2.7%
- New FUTA Tax Rate for the company: 6.0% – 2.7% = 3.3%
| Employee | New FUTA Rate Applied | FUTA Tax Owed |
|---|---|---|
| Alice | 3.3% | $231 |
| Ben | 6.0% (Exempt) | $420 |
| Charlie | 3.3 | $231 |
The total FUTA owed based on liabilities is ($231 + $420 + $231) = $882 total FUTA tax owed.
Credit reduction state
Some states don’t have enough money to cover their unemployment benefits. When this happens, the state borrows money from the federal government. States have two years to pay back their loan. If they have an outstanding balance on November 10 of the second year, the state becomes a credit reduction state until the loan is repaid, which reduces the FUTA tax credit reduction for employers in that state.
This results in a higher FUTA tax rate. For each year the loan remains unpaid, the credit reduction increases by 0.3%, further raising the tax burden on employers.
FUTA Standard State Credit Reduction Rates
| Loan Not Repaid | FUTA Credit Reduction |
|---|---|
| 1st year | 0.3% |
| 2nd year | 0.6% |
| 3rd year | 0.9% |
| 4th year | 1.2% |
| 5th year | 1.5% |
| 6th year | 1.9% |
But that’s not all, the IRS could impose further penalties beyond the standard FUTA reduction rate :
- Benefit Cost Ratio (BCR) Add-on: Could be assessed based on benchmarks if the state hasn’t made significant progress paying back their loan
- 2.7% Add-on: Triggered when a state’s SUTA trust fund balance is low compared to historical levels
- Interest Add-on: Applies if the state has not paid interest due on its loan
💡 Note: These add-ons are not automatic and depend on specific state circumstances. The Department of Labor annually publishes the final list of credit reduction states and their total reduction percentages, including any add-ons. See the Department of Labor’s website for more information and updates.
The IRS requires employers to determine their FUTA credit eligibility each year on IRS Form 940. Employers will use Schedule A of IRS Form 940 to help calculate the additional FUTA tax caused by a credit reduction, or the rare additional penalties and any interest add-on assessments.
How to deposit FUTA tax
If you have federal unemployment tax liabilities, you need to make your deposits on time. Your FUTA tax depositing schedule depends on your FUTA tax liability. Some employers must deposit quarterly while others (e.g. most small businesses) deposit annually. Here’s the breakdown.
If your FUTA tax liability is less than $500 for a quarter, you must carry it forward to the next quarter. The process continues until your cumulative FUTA tax liability exceeds $500. When this happens, deposit your FUTA tax for that quarter. If you reach the fourth quarter and still have a FUTA tax liability under $500, you can make an EFT deposit, pay the taxes with a credit card, or pay with your Form 940 by January 31.
If your FUTA tax is more than $500 for a quarter, you must make quarterly deposits. You have a month after the end of the quarter to deposit FUTA taxes. For example, the year’s first quarter ends on March 31. If you’re paying FUTA tax for the first quarter, deposit your taxes by April 30.
| Quarter | Quarter End Date | FUTA Tax Due Date |
|---|---|---|
| 1st Quarter (January, February, March) | March 31 | April 30 |
| 2nd Quarter (April, May, June) | June 30 | July 31 |
| 3rd Quarter (July, August, September) | September 30 | October 31 |
| 4th Quarter (October, November, December) | December 31 | January 31 |
If the due date falls on a weekend or legal holiday, make your deposit on the next business day.
How to report FUTA tax
Use Form 940 to report your FUTA taxes.
Form 940 is an annual form that covers all of your employees. File it by January 31 each year for the previous calendar year. For example, if you owed FUTA tax in one year, you must file Form 940 by January 31 of the following year.
If you made all your quarterly deposits on time, complete Form 940 by February 10.
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This article is updated from its original publication date of October 12, 2015.
This is not intended as legal advice; for more information, please click here.
