Most entrepreneurs start their own companies because they have a passion for their business, they want to be their own boss, or a combination of the two. Some might also be motivated by the possibility of creating jobs for others, and in the process, helping their local economy and community.
But you’d be hard pressed to find an entrepreneur who was excited about processing payroll for those employees. Sure, you want to pay all your workers a fair wage, but payroll can become complicated — and fast.
Small business owners have multiple tax obligations, and unless you’re starting your own payroll processing company, there are likely several acronyms you’ve never heard before that you suddenly need to know for your business taxes.
In that alphabet soup, you’ve probably come across the terms SUTA and FUTA, or State Unemployment Tax Act and Federal Unemployment Tax Act. If you only worked previously as an employee at a larger company or were self-employed, these taxes were not something you would’ve had to worry about. Unless you worked in Alaska, New Jersey, or Pennsylvania, SUTA and FUTA would not have shown up on your pay stub or your W-2 because in most states they are paid exclusively by employers.
However, if your small business has grown to the point where you now have your own employees, FUTA and SUTA are expenses you’ll need to factor into your payroll processing. But just what do those acronyms mean, and how exactly will it impact your small business’s books?
What is SUTA?
First, it’s important to know just what you’re dealing with when it comes to SUTA. SUTA, or the The State Unemployment Tax Act (SUTA), is a payroll tax paid by all employers at the state level. The SUTA program was developed in each state in 1939 during the Great Depression when the U.S. experienced sky-high unemployment rates. The SUTA, along with the Federal Unemployment Tax Act (FUTA), was instituted to help U.S. workers and to keep the economy afloat.
Eighty years later, the SUTA program is still in effect. The money collected through SUTA tax continues to go into a state unemployment fund on behalf of that state’s employees. The fund is then used to pay state unemployment insurance to employees who have become unemployed through no fault of their own, such as through company layoffs. When you hear of someone collecting unemployment, it’s likely that they are drawing from SUTA funds.
The SUTA rate can vary depending on the state in which your business is located, as well as the employer rating your state assigns your company (more on that below). To further complicate things for small businesses, The Department of Labor provides guidelines that each state must follow.
To help you determine the guidelines for your state, here is a complete list of state agencies responsible for SUTA and other employment regulations, like licensing and labor laws:
What is FUTA?
As you now know, SUTA is a tax paid by all employers at the state level to fund that state’s unemployment insurance. FUTA, or Federal Unemployment Tax, is a similar tax that’s also paid by all employers. However, the money collected from the FUTA tax funds the federal government’s oversight of each state’s individual unemployment insurance programs. In times of high unemployment, states might even borrow from FUTA funds to provide benefits to unemployed workers in their state.
How does SUTA work?
While all employers are required to pay the SUTA tax, the exact amount each company must pay will vary. Currently, there are two factors that determine the tax calculation: the taxable wage base of your company’s employees and the tax rate.
Taxable wage base
First, you’ll need to know how much of your employees’ wages will be subject to the SUTA tax. Known as the taxable wage base, this is the maximum amount of earnings taxed in a calendar year for an individual worker, and that base is determined by each state. Both the wage base and the rate of tax may change from one year to the next.
Next, you’ll need to know your state’s SUTA tax rate. Each state sets a range of minimum and maximum tax rates for state unemployment taxes. The tax rate assigned to a particular firm will be within that specified range, but will vary based on what’s referred to as the assessment. A company’s assessment is based on its experience rating — which the state may change every year — and is determined by the number of former employees who file for state unemployment benefits.
For instance, if a company has a large number of workers who file for unemployment in a given year, that firm will be assigned a higher tax rate. As a result, businesses with the highest employee turnover rates often pay higher unemployment tax rates.
Minimizing your SUTA tax rate
It’s important to note that if your business can reduce employee turnover, you may be able to keep your state unemployment tax rate from increasing. To keep turnover low, be sure you don’t overhire, and when you do hire new employees, try to find workers with diverse skill sets who can be transferred to new departments or locations as the needs of your business change.
Additionally, you can help keep your state unemployment tax rate low by implementing good HR practices — such as providing clear expectations and actionable feedback to current employees — and keeping detailed documentation of any problems with employees. In this way, you are better positioned to prevent job loss in the first place because workers know what is expected of them.
However, if an employee does file an unemployment claim, with documentation to back you up, you will have a better chance of winning the claim, and thereby avoid paying out unemployment insurance.
Calculating the SUTA tax
Now let’s look at an example to see how these two factors work in tandem. Let’s say you run a small marketing agency in Texas with six employees. In 2019, the taxable wage base for employees in Texas is $9,000, and the tax rates range from .36% to 6.36%. Assuming your company received a good assessment, let’s say your SUTA tax rate for 2019 is 2.7%. Using the formula below, we find that in 2019, you would be required to pay $1,458 into your state’s unemployment fund.
($9,000 taxable wage base x 2.7% tax rate) x 6 employees = $1,458 SUTA taxes
How does SUTA impact the FUTA tax?
Properly calculating and contributing SUTA tax is crucial, as it also has an impact on the amount of federal unemployment tax payments, or FUTA tax, a business must submit. This is because businesses get a credit towards their FUTA taxes for their SUTA tax payments.
In general, employers must pay 6% of gross wages, up to a cap of $7,000 per worker, in order to fund federal unemployment taxes (FUTA) for each employee. In all 50 states, employers pay the same 6% rate for each and every worker, but the federal government may change the rate in future years.
Again, an example might help. Returning to our small marketing agency in Texas, let’s assume you have six employees. Given that you must pay FUTA tax only on the first $7,000 of each employee’s wages, we can calculate that your total wages for the first quarter of 2019 are $42,000. Because the FUTA tax rate across all states is 6%, we can determine that your FUTA tax liability is ($42,000 X 6%), or $2,520.
If $2,520 seems like a lot to pay in FUTA tax, don’t despair. Companies often receive a FUTA tax credit for the unemployment contributions they pay to the state in which they do business. You’ll want to check with your state to ensure you pay your SUTA tax on time, as filing deadlines might differ from federal deadlines. Once you’re sure you’re on track to pay your state unemployment taxes on time and in full, there’s good news.
If you file and pay your SUTA taxes on time with the state, you may be eligible for a tax credit when it comes time to file your annual FUTA taxes. You can report the SUTA tax you’ve already paid using IRS Form 940 in order to receive the tax credit — as long as your business is not located in a credit reduction state.
But what is a credit reduction state? These are the states that have borrowed money from the federal government’s unemployment fund to pay their worker’s unemployment insurance and have not yet repaid the debt. While you can always check the Department of Labor’s updated list of credit reduction states for future changes, in 2019, the U.S. Virgin Islands was the only credit reduction state.
So, if your business is located in any U.S. state or territory besides the Virgin Islands, FUTA offers a 5.4% credit to companies that pay their state unemployment contributions on time. When you subtract that 5.4% FUTA credit from the standard 6% rate, this greatly reduces the amount of FUTA tax your company owes to a much lower 0.6%. In this case, our small Texas marketing agency would have a much lower tax liability of ($42,000 x 0.6%), or $252 after the tax credit was applied.
SUTA filing deadlines and tax deposits
As noted above, your company may not be eligible for the FUTA tax credit if it does not file and pay its SUTA taxes on time. It’s, therefore, important to know your state’s filing schedule.
Many state unemployment tax programs require tax deposits each quarter, which is similar to the FUTA requirements. This system allows a company’s accounting department to process the federal and state unemployment tax deposits at the same time. When deposits are submitted, each business also provides a report explaining the deposited amounts. Finally, each company must submit an annual report, detailing their state and federal unemployment tax payments.
Take payroll off your to-do list
Unemployment taxes — both SUTA and FUTA — are an important component of payroll and something that many businesses struggle with. While payroll is notoriously complicated, with a good system in place, you can much more easily navigate the various tax deadlines and fluctuating payments. Luckily, there are many software programs available, such as QuickBooks Online with Payroll, that offer a full suite of payroll tools for businesses of any size.
With software to simplify your SUTA and FUTA calculations, you can get back to doing what you do best — running and growing your small business.