Understanding FUTA: A Comprehensive Guide for U.S. Employers

All revenue associated with these returns is collected for the Department of Labor (DOL), and the DOL is responsible for dispensing the revenue deposited in the FUTA Trust Fund.

Also, DOL monitors the Unemployment Insurance systems for each state and can withhold funds from a state if it does not comply with federal standards.

The FUTA tax rate is 6% on the first $7,000 of an employee’s wages—and if you pay state unemployment taxes, your business is eligible for a tax credit of up to 5.4% to lower your FUTA tax rate for up to 0.6%.

Moreover, if payments are received in the state after the due date, taxpayers are allowed 90% of the amount that would have been allowable as a credit if the payments were made on or before the Form 940 or Schedule H due date.

The FUTA also has a Certification Program — a method the IRS uses to verify with the states that the credit claimed on Form 940 or Schedule H was paid into the state’s unemployment funds.

FUTA covers the costs of UI and Job Service programs in all states and also pays one-half of the cost of extended unemployment benefits (during periods of high unemployment), and provides for a fund from which states may borrow, when necessary, to pay benefits.

State law, on the other hand, determines individual state unemployment insurance tax rates. The State Unemployment Tax, paid to state workforce agencies, is used solely for the payment of benefits to eligible unemployed workers.

Also, states fall under the Credit Reduction criteria when they are unable to repay loans from the Federal Unemployment Fund. Because of this, employers doing business in such states are required to pay an additional tax on their Form 940. This is done by reducing the allowable credit given for timely payments to the states.

FUTA Tax Rate 2023 vs 2024

FUTA tax rate is 6% of eligible wages, which is – 6% of the first $7,000 earned by each employee in a calendar year, and it has been the same for the years 2023 and 2024.

How to Calculate FUTA Tax Liability

Calculating FUTA tax liability is simple.

You’re subject to FUTA taxes on the first $7,000 of each worker’s yearly earnings – excluding exempt payments.

The FUTA tax rate is 6%, and as an employer, you can receive a credit of up to 5.4% against this tax.

Let’s understand through an example:

You run a small business, and in the first quarter – you paid employee X and Y $9000 and $6,000 respectively in wages subject to FUTA taxes.

Since only the first $7000 of wages per quarter are subject to tax, the tax liability turns out to be:

FUTA Liability = (Employee X’s Eligible Wages + Employee Y’s Eligible Wages) x 6%

FUTA Liability = ($7,000 + $6,000) x $6%

The company’s FUTA tax liability would be $780

However, your company can become eligible for a tax credit of $702 ($13,000 x 5.4%)

In that case, your company would only owe $78.

Note:

Employers in states with UC programs approved by the U.S. Labor Secretary and with no outstanding federal loans may credit up to 5.4% points of state unemployment taxes paid against the 6.0% tax rate, making the minimum net federal unemployment tax rate 0.6%.

This tax credit is provided by two separate Internal Revenue Code (IRC) provisions:

1. Section 3304 of the IRC provides for a state tax credit for all employers of up to 5.4%.

2. Section 3303 of the IRC provides an additional tax credit for state employers if the employer paid less than 5.4% in state taxes if the state unemployment tax schedule is such that employers generating the fewest claimants have the lowest tax rates (e.g., experience rates of their employers).

Also, the total of the state tax credits (state plus additional) cannot exceed 5.4%. Conventionally, these two tax credits are generally aggregated and discussed as the 5.4% state tax credit.

Who Pays the FUTA Tax and how does it work?

As you just read above, for most employers, FUTA requires that an employer is required to pay the federal unemployment tax when he:

• Paid wages of at least $1,500 during any calendar quarter
• Employed at least one worker for at least one day of each of 20 weeks in the current or prior year.

The federal coverage requirements impose expensive net tax implications for state employers if they are not met.

Put simply, you won’t be allowed the 5.4% state tax credit if the job is required to be covered under FUTA, but the same job is not covered under the Unemployment Coverage program.

Moreover, states might cover additional employment types that are not required to be covered by FUTA. 

The Unemployment Insurance System doesn’t cover the following employment types in general: 

• self-employment
• work done by relatives 
• work of patients in hospitals
• work by student interns
• work by alien farmworkers
• seasonal camp employment, and  
• railroad workers (who have a separate unemployment program)

There are exceptions to the broad FUTA coverage requirements, and certain sections have different thresholds for coverage, including:

1. Nonprofit employers:

Subject to FUTA tax reporting if the organization employs at least four workers for one day in each of 20 different weeks in the current or prior year.  

2. State or local governments and Indian tribes:

Indian tribal governments are exempt from the FUTA tax if they participate in the state unemployment system for an entire year and are compliant with prevailing unemployment laws. 

Services performed by state or local government parties are exempt from FUTA. 

Religious, educational, scientific, charitable, or other tax-exempt organizations are also exempt from FUTA. 

In some cases, certain nonprofits, state or local government organizations, and federally recognized Indian tribes may opt to be a reimbursable employer in which they have the option to reimburse the UC program for benefits paid to their laid-off employees rather than pay state and federal unemployment taxes. 

3. Agricultural employers:

Agricultural employers are subject to FUTA tax collection and reporting if the employer:

• paid cash wages of at least $20,000 for agricultural labor in any calendar quarter.
• employed 10 or more workers for at least one day in each of 20 different weeks in the current or prior year.  

4. Domestic service employers:

Subject to the FUTA tax reporting if the employer paid cash wages of $1,000 or more for domestic service during any calendar quarter in the current or prior year. 

This includes hiring a nanny, babysitter, maid, housekeeper, or other people to provide services within one’s private home, local college club, or local chapter of a college fraternity.

How to pay FUTA tax

Although Form 940 covers a calendar year, you are supposed to deposit your FUTA tax before you file your return. If the due date for filing a return falls on a Saturday, Sunday, or legal holiday, you may file the return on the next business day.

Also, FUTA tax is required to be deposited at the end of the month after quarter-end. For example, with the first quarter ending March 31, FUTA taxes in Q1 are due for deposit by April 30.

If your FUTA tax liability is more than $500 for the calendar year, you must deposit at least one quarterly payment.

If your FUTA tax liability is $500 or less in a quarter, you can carry it forward to the next quarter.

You can continue carrying your tax liability forward until your cumulative FUTA tax liability becomes more than $500. At that point, you must deposit your FUTA tax for the quarter, and the same for the next two quarters.

If your FUTA tax liability for the fourth quarter (plus any undeposited amounts from earlier quarters) is $500 or less, you can either deposit the amount or pay the tax with your Form 940.

You are required to deposit your FUTA tax by the last day of the month after the end of the quarter.

And if you’re required to make a deposit on a day that’s not a business day, the deposit is considered timely if you make it by the close of the next business day i.e. any day other than a Saturday, Sunday, or legal holiday.

For example, if you’re required to make a deposit on a Friday and Friday is a legal holiday, the deposit will be considered timely if you make it by the following Monday (if that Monday is a business day).

In years where there are credit reduction states, you must include liabilities owed for credit reduction with your fourth quarter deposit.

Also, you must use electronic funds transfer (EFT) for all federal tax deposits.

Federal Unemployment Tax Act (FUTA) vs. State Unemployment Tax Act (SUTA)

As you read above, FUTA is an unemployment tax that employers pay to the federal government to fund unemployment insurance programs.

Similarly, The State Unemployment Tax Act (SUTA) is a state version of the FUTA tax—which means that rather than funding the federal government’s unemployment and benefits programs, employers pay the state government to fund unemployment insurance programs.

When it comes to eligibility on who is required to pay these taxes, the criterion is almost similar.

Here are some of the key overlapping distinctions between FUTA and SUTA:

1. FUTA is for federal unemployment insurance, while SUTA is for state unemployment insurance. 
2. FUTA and SUTA taxes vary, considering that every state has its own regulations for the SUTA tax. And because state rules vary, every employer will receive the SUTA rate they should pay within a calendar year. 
3. Both SUTA and FUTA taxes are paid out of a company’s gross wages—that means before any deductions or withholdings are taken out. The amount paid depends on how many employees you have, how much they earn, and how long they’ve been unemployed.
4. FUTA covers all types of income: wages, tips, commissions, bonuses—anything that falls under the term “wages.” In contrast, only wages paid by a company fall under SUTA. 
5. Under FUTA, employers are required to take 6% as the unemployment tax rate from an employee’s first $7,000 in wages. However, you can lessen the burden of FUTA tax by often paying SUTA tax. SUTA gives employers a tax credit of up to 5.4% only if they make payments on time and in full. This means that if you qualify for the highest credit, expect 0.6% as the net rate.
6. If your company does business in multiple states and you have employees who live in different states, then you’ll have to pay both FUTA and SUTA taxes. 
7. For the SUTA tax, you simply need to stay abreast with the current state rate. You will then multiply the total wages paid to employees by the current rate. 

For instance, if an employee receives $4000 bi-weekly and the SUTA tax rate is 6%, you should be able to pay $240 in taxes. Remember, your tax payment will be limited to the wage limit within your state.

Now that you understand FUTA vs SUTA, let’s uncomplicate FUTA and FICA.

Federal Unemployment Tax Act (FUTA) vs. Federal Insurance Contributions Act (FICA)

Both FUTA and FICA taxes are federal payroll taxes, but they serve different purposes, have different rates and income limits, and apply to different groups of employees. 

Following are the key differences between FUTA and FICA:

FITA vs FICA: Key Differences