Key Takeaways
- Employer-only payroll tax funding unemployment benefits.
- 6% tax on first $7,000 wages per employee.
- Up to 5.4% credit reduces FUTA to 0.6%.
- File annually with IRS Form 940 by January 31.
What is Federal Unemployment Tax Act (FUTA)?
The Federal Unemployment Tax Act (FUTA) is a U.S. federal law enacted in 1939 that imposes a payroll tax on employers to fund unemployment compensation programs. This tax supports workers who lose jobs through no fault of their own by creating a nationwide safety net via a federal-state partnership that acts as a backstop to state unemployment funds.
Unlike other payroll taxes, FUTA is paid solely by employers and is never deducted from employee wages, establishing a reliable source of funding for unemployment benefits and administrative costs.
Key Characteristics
FUTA has distinct features that affect employers and state unemployment systems:
- Tax Rate and Wage Base: Employers pay a 6% tax on the first $7,000 of each employee’s annual wages, with a maximum gross liability of $420 per employee.
- Credits: Employers can receive a credit up to 5.4% for state unemployment taxes paid, reducing the effective rate to 0.6% in most cases.
- Filing Requirements: Annual reporting is done via IRS Form 940, with potential quarterly deposits if liabilities exceed $500.
- Exemptions: Certain nonprofits and household employers may be exempt or subject to different thresholds under the Fair Labor Standards Act (FLSA).
- State Partnership: FUTA works alongside state unemployment tax acts (SUTA) to ensure workforce stability and proper fund management.
How It Works
Employers calculate FUTA tax by applying the 6% rate to the first $7,000 of annual wages per employee. They then subtract eligible state tax credits, which can lower the rate to 0.6%. If the state has outstanding federal loans, credits may be reduced, increasing the net tax owed.
Employers submit Form 940 by January 31 each year to report their FUTA liability and credits. Accurate payroll records and compliance with state conformity rules are essential to avoid IRS notices or recertification requests. Payroll software often automates these calculations to ensure timely and accurate filings.
Examples and Use Cases
FUTA applies broadly across industries, impacting employers of all sizes. Here are some practical examples:
- Airlines: Large employers like Delta and American Airlines pay FUTA tax on covered employee wages to contribute to the federal-state unemployment system.
- Household Employers: If you pay a household worker more than $1,000 in any quarter, you must pay FUTA taxes on the first $7,000 of wages.
- Nonprofits: IRS-recognized 501(c)(3) organizations are typically exempt from FUTA, but must verify eligibility annually.
Important Considerations
When managing FUTA obligations, it’s crucial to monitor state tax credits yearly as they directly affect your net tax rate. States with outstanding federal loans may reduce your credit, increasing your FUTA liability.
Employers should also ensure compliance with both federal FUTA rules and relevant ability to pay taxation guidelines. For those interested in investment diversification, consulting guides like best low-cost index funds and best large-cap stocks can provide broader financial context alongside payroll tax planning.
Final Words
FUTA imposes a crucial employer-only tax that funds unemployment benefits and supports state programs. Review your state’s SUTA rates and ensure accurate reporting to maximize available credits and minimize your FUTA liability.
Frequently Asked Questions
FUTA is a U.S. federal law enacted in 1939 that imposes a payroll tax on employers to fund unemployment compensation programs. It creates a nationwide safety net for workers who lose jobs through no fault of their own by supporting federal-state unemployment benefits.
Most employers must pay FUTA tax on the first $7,000 of each employee's wages annually. However, certain employers like IRS-recognized 501(c)(3) nonprofits are exempt, and household employers must pay if they pay over $1,000 in cash wages in any calendar quarter.
The standard FUTA tax rate is 6% applied to the first $7,000 of each employee’s annual wages, resulting in a maximum tax of $420 per employee. Employers can reduce this rate by up to 5.4% through state unemployment tax credits, lowering the effective rate to 0.6%.
Employers who pay state unemployment taxes can receive a credit of up to 5.4% against the 6% FUTA tax rate. This credit reduces the net FUTA tax owed, but if a state has outstanding federal loans, the credit may be reduced, causing employers to pay a higher FUTA rate.
Employers file their FUTA tax annually using IRS Form 940 by January 31 following the tax year. Payments are made quarterly if the FUTA tax liability exceeds $500 in a quarter; otherwise, the tax is paid with the annual return.
No, FUTA taxes are an employer-only tax and are never deducted from employee wages. Employers are solely responsible for paying this tax to fund unemployment compensation programs.
FUTA works alongside state unemployment tax acts (SUTA), providing federal funds to support state programs. Employers typically pay both FUTA and state taxes, with FUTA serving as a federal backstop and funding extended benefits or loans to states during economic downturns.
