What Is FUTA? An Overview of the Federal Unemployment Tax Act

Do you pay wages of $1,500 or more to your employees in a calendar quarter? Then you may be responsible for paying this tax annually.

What Is FUTA?

The Federal Unemployment Tax Act created a program to help states pay for unemployment benefits for workers who have been terminated (other than for gross misconduct). If you pay wages of $1,500 or more to employees, you must pay this tax annually. This tax is in addition to any state unemployment insurance you may owe.

Funds for unemployment insurance are also collected at the state level through the State Unemployment Tax Act (SUTA). Both FUTA and SUTA are set up to fund all unemployment insurance programs, which provide payments made to employees who have been terminated for reasons outside their control.

What Is SUTA?

The State Unemployment Tax Act, or SUTA, is a state-level tax paid by employers to fund unemployment compensation. FUTA and SUTA are both employer taxes, but FUTA is managed and collected by the IRS at the federal level, while SUTA is administered separately from FUTA, and managed and collected by individual state governments.

Each state develops its own state unemployment insurance taxes, or SUI taxes, independently, to determine how much employers must contribute through payroll deductions. FUTA contributions typically go toward benefits for employees who lose employment after being laid off due to events outside their control such as death or illness in the family. On the other hand, SUTA funds unemployment benefits for individuals who have lost jobs for other reasons outside their control that may vary from state to state. For example, if Colorado has considerably less work available for its residents than California, Colorado may have a higher SUTA to ensure unemployment coverage is available for all the people struggling to find jobs. Employers in all states are therefore required to pay both FUTA and SUTA contributions according to applicable regulations to ensure adequate funding of all state unemployment insurance programs across the country.

What Is Unemployment Insurance?

Unemployment insurance is a program managed by the federal government through FUTA. This program provides financial assistance to employees and their families who have been laid off due to no fault of their own. The money given out comes from taxes collected from employers on a quarterly basis under FUTA, which helps cover the cost of managing unemployment. This assistance is available for up to 26 weeks or until the individual finds a new job or achieves self-sufficiency. It helps provide some financial relief so that individuals can continue providing for themselves and their families during periods of unemployment.

Who Pays FUTA Tax and How Does It Work?

FUTA is a tax that employers pay to the federal government. Employees do not pay any FUTA tax or have anything subtracted from their paychecks. The tax applies only to the first $7,000 of wages to each employee (other than wages that are exempt from FUTA). This wage threshold has been in effect since 1983, but could be changed by Congress in the future.

There is no FUTA tax for self-employed individuals. Thus, if you are a partner, there is no FUTA on your distributive share of partnership profits. If you engage independent contractors in your business, you don't pay FUTA on payments to them.

The basic FUTA rate is 6%. However, you may receive a credit for timely payment of state unemployment tax of 5.4%. This brings the net federal tax rate down to 0.6%. Applying this rate to the first $7,000 of wages for each employee results in a tax of up to $42 per employee. There had been a 0.2% surtax in effect starting in 1983 but after numerous extensions it ended in 2007.

Note: If a state has not repaid borrowing from the federal government to cover its unemployment benefits liability, it may be a "credit reduction state." This means the amount of the credit for state unemployment tax is reduced and the FUTA rate is effectively increased. The designation of credit reduction states is made by the Department of Labor.

FUTA vs FICA

FUTA, which is for unemployment benefits for employees, should be distinguished from FICA, which is a separate tax paid by both employers and employees to provide Social Security and Medicare benefits.

The FICA tax is 6.2% on taxable compensation up to a fixed amount annually (e.g., $160,200 in 2023) for the Social Security portion and 1.45% of taxable compensation for the Medicare portion (without any limit).

The same amount is paid by the employer and the employee. For example, if an employee earns $50,000, the employer's FICA tax is $3,825 (6.2% of $50,000 + 1.45% of $50,000). The employee pays the same $3,825, which is withheld from their wages.

How To Calculate FUTA Tax Liability

Figuring out how to calculate FUTA tax liability as an employer may seem complicated at first, but it's possible to streamline the calculation by following a few key steps.

1. Calculate the total wages paid to all employees for the previous quarter. If this number is greater than $1,500, you must pay taxes under FUTA and should continue on to step 2.
2. For each employee, multiply the current FUTA tax rate (6.0% for 2023) by the amount of wages paid to the employee, up to a maximum of $7,000 annually.

For example, if a company has 35 employees who each make at least $7,000 in a single year, the total summary of eligible wages paid would amount to $245,000 ($7,000 x 35 = $245,000). Multiplying this total by 6.0% results in a FUTA liability of $14,700 ($245,000 x .06 = $14,700). This tax liability does not include any SUTA liability that may also be due from the employer.

Please note that the above calculation shows the liability before the tax credit is taken out. Employers typically have a credit of 5.4% that they need to account for.

Paying FUTA Tax

Even though there is an annual reporting for FUTA (explained below), the tax must be deposited at least quarterly if it is more than $500 per quarter. More specifically, if FUTA tax liability is more than $500 for the calendar year, you must deposit at least one quarterly payment. If FUTA tax liability is $500 or less in a quarter, carry it forward to the next quarter and continue to do so until your cumulative FUTA tax liability is more than $500. At that point, you must deposit your FUTA tax for the quarter.

Deposits are made through the Electronic Federal Tax Payment System (EFTPS). If you don't exceed the $500 threshold, you can pay the tax when you file your annual FUTA tax return.

Reporting FUTA Tax

The tax is reported on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The return must be filed if:

• You paid wages of $1,500 or more to employees in any calendar quarter during the current or previous year.
• You have one or more employees for at least some part of a day in any 20 or more different weeks in the current or previous year.

Special rules apply to employers of agricultural workers. They are provided in the Instructions to Form 943. Form 940 must be filed by January 31 of the year following the year to which it relates (e.g., January 31, 2024, for 2023).

Returns can be mailed or e-filed. If you aren't sure how to calculate, file, or meet your FUTA obligations, a tax professional can help.

What Is the FUTA Tax Rate and Limit for 2023?

Consistent with prior years, the effective FUTA rate for 2023 is 6%, meaning employers should withhold 6% of the first $7,000 of an employee's wages. As $7,000 is the limit. The tax credit of up to 5.4% for state unemployment tax is also unchanged from previous years.

Companies must continue to withhold FUTA if they have paid wages of $1,500 or more in any calendar quarter in 2021 or 2022, or they have paid employees for at least a portion of a day in any 20 weeks in 2021 or 2022. Separate tests are applied toward agricultural workers and household workers.

FUTA Frequently Asked Questions (FAQs)

What Is FUTA Withholding?

FUTA withholding refers to the contributions employers make to the Federal Unemployment Tax Act (FUTA). The purpose of these taxes is to provide a safety net for eligible unemployed individuals in times when the economy is struggling or when employees become unemployed for reasons outside of their control.

How Much Is FUTA?

The FUTA rate for 2023 is 6.0% of the first $7,000 in wages for all employees, or approximately $420 per employee (assuming every employee makes at least $7,000 per year).

When Are FUTA Taxes Due?

FUTA taxes must be paid each year on or before the last day of the month following the end of the calendar quarter for employers who have at least $500 in cumulative liability. This means that FUTA taxes are due quarterly, with payment deadlines occurring on January 31, April 30, July 31, and October 31.

Who Is Exempt From FUTA?

According to the Federal Unemployment Tax Act, employers who pay wages of household employees, including nannies and housekeepers, are not required to pay taxes. Additionally, a variety of organizations such as religious groups and government entities are exempt from FUTA. If an employer is covered by any state unemployment insurance laws, they may also be considered exempt from FUTA. Furthermore, if an employer pays wages totaling less than $1,500 per quarter for all quarters of the previous two tax years, then they may also not be required to pay FUTA.

What Does FUTA Stand For?

FUTA stands for the Federal Unemployment Tax Act.

Are Household Employees Subject to FUTA?

No, under the FUTA regulations, household employees and the employers who pay them are exempt from FUTA taxes.

Do the Self-Employed Pay FUTA?

No, similarly to household employees, self-employed individuals are exempt from FUTA taxes according to the regulations.

Are FUTA and UI the Same Thing?

Federal Unemployment Tax Act (FUTA) and unemployment insurance (UI) are two different things. FUTA is a broad-based federal tax imposed on all employers that applies to the first $7,000 of wages paid to each employee in a calendar year. The collected taxes are used by the federal government to fund unemployment insurance programs. On the other hand, UI provides assistance to individuals who have lost their job through no fault of their own. It pays a portion of an individual's income while they are searching for new employment.

Is FUTA the Same As Social Security?

Many people get confused when they hear the terms FUTA and Social Security, but they are not the same. FUTA stands for Federal Unemployment Tax Act and it is a federal law that requires employers to pay an additional amount of tax on top of the federal income tax and other payroll taxes. Social Security on the other hand is a benefits program funded by tax dollars that provides retirement, disability, widows' and survivors' benefits along with health insurance through Medicare, which enables retired citizens to stay financially afloat.

Is FUTA Tax-Deductible?

Determining whether FUTA taxes are deductible for employers depends on their state and federal policies. In general, these payroll taxes paid by employers to the federal government can be used to offset state unemployment taxes paid. That is, FUTA tax can be deducted from what employers owe the state. It is important for businesses to understand the implications of how each law relates to deductions to ensure accuracy in both finances and reporting when filing taxes annually.

Doing Payroll Taxes Correctly Is Important

It is critical for employers to understand how payroll taxes, including FUTA, work. Employers must pay their full FUTA liability before their filing date each quarter to remain compliant with federal regulations and avoid potential financial penalties. Failing to properly withhold or manage payroll taxes can lead to costly legal penalties, fines, and a tarnished corporate reputation.

Ultimately, enlisting the help of a knowledgeable service provider to help with payroll taxes is worth the peace of mind that comes from correctly filing and remitting these liabilities on time each period.