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Employers in FUTA credit reduction states pay increased FUTA tax.

What Are FUTA Credit Reduction States?

In order to pay unemployment benefits, states require that employers pay a state unemployment tax or insurance. If a state cannot afford to pay unemployment benefits with the money generated from the tax, the state has to take out a federal loan.

FUTA taxes

The Federal Unemployment Tax Act (FUTA) is a payroll tax that helps fund the federal unemployment loans. Most employers have to pay FUTA tax based on their employees’ wages.

The standard rate for FUTA tax is 6.0% on an employee’s first $7,000 earned every year. But, most employers do not have to pay the full 6.0%. Employers can receive up to a 5.4% tax credit on Form 940, meaning they will only have to pay 0.6% for their FUTA taxes.

Credit reduction states defined

When a state takes out a federal unemployment loan, the state must pay the loan by November 10 in the second year of having the loan. If the state cannot pay off the loan, the state becomes a FUTA credit reduction state. Employers in a credit reduction state receive a reduced FUTA tax credit.

When a state becomes a credit reduction state, the total FUTA credit is reduced by 0.3%. That means instead of a 5.4% tax credit, businesses are only able to claim a 5.1% credit.

Employers will face another 0.3% tax credit reduction in both the third and fourth years of their state having an unpaid federal unemployment loan.

When a state has an unpaid federal unemployment loan for five years, employers might face an additional FUTA penalty called a benefit cost-rate (BCR). The BCR is an add-on credit reduction that is calculated by the federal government. States subject to this add-on can apply for a BCR waiver, but the waiver may or may not be granted.

Once a state pays off its loan, the full credit reduction rate is restored.

2015 FUTA credit reduction states

The 2015 FUTA credit reduction states include:

  • California: 1.5% credit reduction
  • Connecticut: 2.1% credit reduction
  • Ohio: 1.5% credit reduction
  • U.S. Virgin Islands: 1.5% credit reduction

You can find all reduction rates in Schedule A (Form 940). The 2016 credit reduction states will be determined in November 2016.

How businesses deal with a credit reduction

If you operate in a state that has been given a credit reduction, you will pay increased FUTA taxes when you submit Form 940. Where you would enter the standard credit amount of 5.4%, you will now have to factor your taxes using the smaller credit. Any additional payment due must be paid in full by January 31 of the next year.

If you have employees in multiple states, you must calculate the various FUTA tax credits for each state. Every state that you operate in must be listed on your Form 940.

How can you prevent a credit reduction?

There is not a lot an employer can actually do to prevent a FUTA credit reduction because the loans are taken out by the state. You can encourage your state legislators to avoid taking out loans and to construct a budget that guarantees the state can meet all of its unemployment benefit liabilities.

Save your time by not stressing over changes in state and federal policy. Our online Full Service Payroll services will calculate your payroll taxes and we will remit the taxes for you. Try a free trial today!

This article was originally published on 1/10/2013.

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