What is Form 940? A guide to the Federal Unemployment Tax Act (FUTA)

Small business employment has been on the decline, with more than 50,000 jobs lost in 2024 alone, according to the QuickBooks Small Business Index. Thankfully, both the federal and state governments have unemployment programs in place to help individuals who need them. 

These programs are funded by the employer through the Federal Unemployment Tax Act (FUTA). Form 940 is the document used to record and reconcile the tax payments you make throughout the year. 

In this article, we’ll explore which businesses need to pay FUTA tax, how to calculate your FUTA tax with Form 940, and your payment options.

What is Form 940?

Who files Form 940?

How Form 940 works: The FUTA tax rate explained

When to file and pay Form 940

How to fill out Form 940

Find peace of mind come tax time

What is Form 940?

Tax Form 940 is the form business owners use to report their Federal Unemployment Tax Act (FUTA) liability. Most employers are required to pay FUTA tax, which the government uses to support state unemployment insurance programs. Unlike other types of federal taxes, this one is not withheld from employee pay.

Usually, a business pays FUTA tax quarterly but files Form 940, the Employer’s Annual Federal Unemployment Tax Act (FUTA) Tax Return, annually. The goal is to reconcile the tax liability for the calendar year versus the payments made.

Who files Form 940?

Most businesses with paid employees must file Form 940 by the end of the year. The IRS sets two main criteria for needing to file a 940: 

• Your business paid wages in excess of $1,500 to employees in any one quarter of the calendar year
• Your business had at least one employee (part-time, full-time, or temporary) for at least 20 weeks during the calendar year

If either of the two criteria applies, then you need to file a 940 return, unless you meet any of the limited exceptions we’ll discuss next. 

Exceptions and specific rules for Form 940

There are particular scenarios where filing an IRS Form 940 has different rules or is unnecessary, including: 

• Household employers: The FUTA tax threshold is lower, at $1,000 in wages per quarter. For employers with both household employees and nonhousehold employees who choose to report tax liability quarterly using Form 941, an annual Form 940 return will be required. Otherwise, employers will file on their 1040 instead. 
• Agricultural employers: The wage thresholds are higher for businesses that employ farmworkers. The two criteria for filing a 940 are paying wages of $20,000 or more in any one quarter or employing 20 or more farmworkers for at least 20 weeks. 
• Indigenous tribal governments are exempt from paying FUTA tax and filing a Form 940, provided they participate in a state unemployment program for the full calendar year.
• Tax-exempt organizations: Businesses that qualify as a section 501(c)(3) organization are exempt from paying FUTA tax and filing a 940. However, if they pay employees on behalf of a non-Section 501(c)(3) business, then they will have to pay the tax. 
• State and local government employers are entirely exempt from paying FUTA tax and filing a 940.

If your business does not qualify under one of the above exceptions, you'll need to pay FUTA tax and file your FUTA tax return annually.

How does Form 940 work? The FUTA tax rate explained

When someone finds themselves unemployed, they can apply for state unemployment benefits. To protect access to these benefits, the federal government created the FUTA tax to help fund these state-level benefits as needed. 

The total FUTA tax rate is 6% on the first $7,000 of an employee’s wages, or $420. This is the maximum taxable wage. FUTA tax payments will need to be paid quarterly based on how much of the first $7,000 was spent in that quarter. 

This payroll tax is exclusively paid by you, the business owner, and is recorded on your Form 940 return. 

The role of state unemployment tax credits

The federal unemployment program serves as a backup to state unemployment insurance (UI) systems. Because of this, the IRS will give you a credit on your FUTA tax when you pay into a state unemployment system. 

While the amount you pay into a state system will vary depending on individual program regulations, the IRS will give you a 5.4% credit. 

This credit means your FUTA tax will be reduced to 0.6% (6% - 5.4%). On $7,000 in wages, this comes to $42 per employee.

Credit reduction states

While the IRS will generally give you a FUTA tax credit of 5.4%, this credit can be reduced in one circumstance: when the state has an outstanding loan from the federal government for paying unemployment benefits. 

As a business that pays employees in one of these credit reduction states, your overall FUTA tax will increase. For instance, according to the Department of Labor’s list of FUTA credit reductions, Connecticut's FUTA credit will be reduced to 3.4%. This leaves an effective FUTA tax rate of 2.6%, or $182 per employee.

When to file and pay Form 940

Form 940 is an annual return due on January 31 each year. This is the same date your FUTA tax payment for the 4th quarter of the previous year is due. 

If you have deposited all of your FUTA taxes on time throughout the year, the IRS gives you an extra 10 days to file your 940 return. 

Quarterly deposits

FUTA tax deposits are generally due quarterly on the last day of the month following the end of the quarter. However, you can deposit less frequently. Per the IRS, in quarters where your tax liability is less than $500, you can postpone the deposit until the next quarter. 

For instance, if your FUTA tax liability on March 30th (end of the 1st quarter) is $317, you don’t have to deposit your FUTA tax. 

Now, let’s say that on June 30th (end of the 2nd quarter), your existing liability plus new liability equals $513. Since this exceeds $500, you’ll have to deposit the full amount for quarters 1 and 2 by July 31.

Payment methods

When depositing your FUTA tax, you’ll need to use an EFT method (electronic funds transfer). The preferred option is the Electronic Federal Tax Payment System (EFTPS). The free system allows you to schedule and track all your tax payments. However, you'll need to make deposits by 8:00 PM (ET) on the day before the due date. 

Another option is to have a financial institution, tax preparer, or other trusted third party submit an EFT payment on your behalf. 

If you were unable to submit an EFT deposit by the 8 PM deadline, your final option is to initiate a same-day wire payment with the Federal Tax Collection Service (FTCS). The drawback here is that you'll need to notify your bank in advance and may be subject to a wire transfer fee.

How to fill out Form 940

There are seven sections to the Form 940 return. From determining which states you owe taxes to and calculating your liability to making credit adjustments, filling out this form accurately can be tough. Here’s some guidance on how to get started on filling out each section.

Section 1: Business information

Like many other tax forms, in the first section you’ll need to fill out your basic business information, such as address and EIN, and select the type of return (if applicable). You’ll also need to specify whether or not you are a multi-state business. It’s important to note that this is determined by where your employees live, not where your business locations are. 

For instance, let’s say you operate a small marketing firm in Idaho. If all of your employees work in Idaho, you're a single-state employer. Now, let’s say you hire a graphic designer who works remotely from Colorado. This now means you have to pay UI in more than one state, making you a multi-state employer. 

If you need to pay UI in more than one state, or your state is subject to a credit reduction, you’ll also need to complete Schedule A for Form 940. 

Section 2: FUTA tax calculation

The second section of the Employer’s Annual Federal Unemployment Tax Return contains the base calculations for FUTA tax liability. 

To begin, you’ll need to record all payments made to employees, including wages, tips, commissions, fringe benefits, etc. Then you’ll specify how much of this pay is not subject to FUTA tax. 

Remember, only the first $7,000 of pay is taxable, and certain pre-tax payments, such as retirement account contributions and dependent care, are exempt from FUTA tax.

You can then subtract the nontaxable total from your full payments to get your taxable amount. The final step is to multiply this number by 0.006. 

Let’s take a look at an example scenario. Business A has paid employees $126,000 during the calendar year. Of that, $16,000 was for retirement contributions, and $78,500 was for payments exceeding the first $7,000. This leaves you with $31,500 in FUTA taxable wages. Multiplying this by 0.6% yields a liability of $189.

Section 3: State tax credits

Part 3 of Form 940 addresses potential adjustments. Issues like state credit reductions or having wages you paid exempt from state UI tax could increase your overall FUTA tax liability. 

For instance, Jim owns a small family business (sole proprietorship) in Texas. All of his employees are family members, exempt from state unemployment taxes. As a result, Jim’s FUTA tax rate will increase to 6%. 

Here’s another example: Terry owns a small brokerage firm in Maine. She employs two brokers who are paid 100% on commission and are exempt from SUTA tax. However, she also pays a receptionist who has taxable wages. Because of this, she’ll need to use the Line 10 worksheet to determine her adjustment amount. 

In this final scenario, let’s look at a credit reduction state. George operates a business in Connecticut. The state currently has an unpaid federal loan, so George will need to pay additional FUTA tax based on the 2% credit reduction. This means he’ll have a total FUTA tax rate of 2.6%.

Section 4: Total FUTA tax due

Once you’ve calculated your initial FUTA tax liability and adjustments, it's time to put down the final total in Part 4 and reconcile with what has already been paid. 

If you have underpaid, you’ll need to either deposit the tax immediately or, if it's less than $500, submit it with your 940 return. If you’ve overpaid, you can apply it to next year’s return or receive a refund. 

Let’s take a look at a quick comparison of two different businesses: 

• Business A has a liability of $11,800 for the year with no adjustments. Throughout the year, they deposited $11,900 in FUTA tax. Business A applies the $100 overpayment to next year’s return. 
• Business B has a liability of $8,000 with $3,200 in adjustments. This brings their total liability to $11,200, but they’ve only deposited $8,300. With an underpayment of more than $500, Business B will need to deposit the $2,900 owed immediately.

Find peace of mind come tax time 

Calculating your FUTA tax accurately can get complicated. While Form 940 offers guidance, there is still the chance you could make a costly mistake when reconciling your FUTA payments. 

Instead of trying to navigate the process on your own, you can get help by using an all-in-one software solution. From helping you manage payroll and invoicing to filing your taxes and claiming all available tax deductions for your business, QuickBooks accounting software can offer you peace of mind this tax season.