The Federal Unemployment Tax Act (FUTA) was passed to fund unemployment compensation payments to workers who have lost their jobs. FUTA, along with state unemployment systems, collect funds and distributes them to the unemployed.
FUTA is one the elements of payroll that business owners often misunderstand. Here is some context about the FUTA tax operates and its impact on businesses.
Who Pays the FUTA Tax?
Employers pay 6% of gross wages, up to a cap of $7,000 per worker, to fund federal unemployment taxes for each employee. Generally, employers pay the same 6% tax rate for all workers, thought it’s possible the federal government will change the rate in future years. This is only a business expense. No FUTA taxes are deducted from a worker’s pay.
In addition to FUTA, each state has its own unemployment plan. If you have employees in more than one state, your firm may have to comply with multiple state unemployment requirements.
Fortunately, FUTA offers a 5.4% credit for all state unemployment contributions if your state is a credit reduction state. Credit reduction states borrow money from the federal government to fund state unemployment liabilities, and many states participate in the program. The credit reduces the net amount of FUTA tax your company owes to (6% – 5.4%), or 0.6%.
When Do I Pay FUTA?
A business deposits its FUTA tax liability each quarter. A FUTA tax liability of $500 or less in a quarter is not paid until the following quarter. FUTA deposits must be paid by the last day of the month after the end of the quarter.
Businesses complete and send IRS Form 940 with each FUTA payment. The IRS.gov site explains that the due date for filing the Form 940 is January 31 of the following year. So, the 2017 Form 940 was due on January 31st, 2018. However, if you deposited all your FUTA tax when it was due, you may file Form 940 by February 12, 2018.
What About State Unemployment Taxes (SUTA)?
Taxes are also assessed by state employment agencies. There are two factors that determine the tax calculation: the wage base and the tax rate. The wage base is the maximum amount of earnings taxed in a calendar year, and base is determined by each state. Both the wage base and the rate of tax may change from one year to the next.
Companies can take steps to minimize state unemployment taxes, because the tax rate assessed is based on the number of employees who have filed unemployment claims in the past. Businesses with high employee turnover generate more unemployment claims, so the system taxes those firms at a higher rate.
If your firm can reduce employee turnover, you may be able to keep the state unemployment tax rate from increasing. Businesses receive a FUTA credit for unemployment contributions to a state. However, the state payments must meet certain FUTA payment deadlines.
How Is FUTA Calculated?
Assume, for example, that your total wages for the first quarter of 2017 are $21,000. The $21,000 is the first $7,000 of payroll you paid to three different employees. Your FUTA tax liability is ($21,000 X 0.06 = $1,260).
Let’s also assume that your business operates in a credit reduction state. Your firm pays state unemployment tax on the same $21,000. You would receive a 5.4% credit, which would reduce your net FUTA cost to ($21,000 X 0.6%), or $126.
For state unemployment taxes, assume that you must pay 4% on the same $21,000 amount, or $840. You would subtract the $840 in state unemployment taxes from the $1,260 FUTA calculation, and you would owe the IRS $420.
Hire an Expert
Every business owner needs to understand the FUTA tax process and make payments on time to avoid penalties. Consider hiring a CPA firm or a payroll company to help you process payroll accurately.