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 of your workers a fair wage, but payroll can become complicated.
Small business owners have multiple tax obligations, and there are likely several acronyms you’ve never heard before that you 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 worried about.
In many states, SUTA and FUTA are not posted to your pay stub because the cost is paid in full by the employer.
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?
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?
SUTA is a tax paid by employers at the state level to fund their 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 program. 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 varies. Currently, there are two factors that determine the tax calculation: your firm’s taxable wage base and the tax rate.
Taxable wage base
You need to know how much of each employee’s 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 is within that specified range, but will vary based on an individual company’s assessment.
A firm’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, 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 minimize employee turnover, because workers know what is expected of them.
If an employee files an unemployment claim, use your documentation to improve the chances of getting the claim denied, 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%. Assume that your company receives a good assessment, and your SUTA tax rate for 2019 is 2.7%. Using the formula below, 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 paying 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. Each business receives a credit toward FUTA taxes, based on 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. 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.
You can check the Department of Labor’s updated list of credit reduction states for future changes. In 2019, however, the U.S. Virgin Islands was the only credit reduction state.
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 you don’t file and pay its SUTA taxes on time. Therefore, it’s 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 completing the work can be a struggle. 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.