Title: The Federal Unemployment Tax Act (FUTA) — What Employers Need to Know and Practical Steps to Comply
Summary
The Federal Unemployment Tax Act (FUTA) requires employers — not employees — to pay a federal payroll tax that helps fund state unemployment insurance and federal job service programs. The statutory FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee per year (the FUTA wage base). Most employers who pay state unemployment taxes can claim a credit of up to 5.4%, reducing the effective federal FUTA rate to 0.6%. This article explains who must pay, what wages are taxable, how to calculate and pay the tax, key exceptions, and practical compliance steps.
Sources: Investopedia (Investopedia’s FUTA overview) and the IRS (Form 940 and FUTA guidance). See links at the end.
Key concepts (at a glance)
– Taxpayer: Employer only (employees do not pay FUTA directly).
– Statutory rate: 6.0% on the FUTA wage base.
– Wage base: The first $7,000 in wages paid to each employee each year.
– Typical net rate: Up to 5.4% credit for timely state unemployment tax payments → effective federal rate of 0.6%.
– Reporting: Annual Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax Return).
– Deposits: Quarterly if you owe $500 or more in FUTA for the year; otherwise you may report and pay annually.
Who must pay FUTA (general rules)
Businesses: A business is generally subject to FUTA and required to file Form 940 if it meets either of these conditions during the current or preceding calendar year:
– It paid total wages of a specified threshold in any calendar quarter; or
– It employed one or more persons (including part-time) for a specified minimum number of weeks during the year.
Household employers: If you hire household help (nannies, housekeepers, private caregivers), you may be a household employer subject to FUTA once your cash wages exceed the household-specific threshold in a calendar quarter. Household employers can elect to report FUTA via Schedule H (Form 1040) instead of Form 940.
Agricultural employers: Different thresholds and tests apply; some farm employers are subject to FUTA if they meet certain wage or worker-count thresholds.
Exempt entities and payments
– Tax-exempt organizations: Many nonprofit organizations (e.g., certain religious, educational, and charitable organizations) are exempt from FUTA, but there are exceptions — wages paid by certain entities on behalf of non-qualifying organizations may be taxable.
– Government employers: Services performed for state or local governments are generally exempt.
– Indian tribal governments: Generally exempt from FUTA if they participate in state unemployment systems for the year and comply with state requirements.
– Exempt wages: wages paid to a spouse, child under age 21, or parents (in some family employment situations), most fringe benefits, group-term life insurance benefits, and employer retirement contributions are not subject to FUTA.
How FUTA tax is calculated (step-by-step)
1. Identify each employee’s annual FUTA-eligible wages up to the first $7,000 per employee.
– Example: Employee A earns $10,000 in wages during the year. FUTA-eligible wages for that employee are $7,000 (cap reached). Employee B earns $5,000 — FUTA-eligible wages are $5,000.
2. Sum eligible wages for all employees.
– Example: $7,000 + $5,000 = $12,000 total FUTA wage base.
3. Apply the statutory FUTA rate (6.0%) to the total FUTA wages to get gross FUTA tax.
– Example: $12,000 × 6.0% = $720 gross FUTA tax.
4. Apply the state unemployment tax credit (up to 5.4% if you paid state UI taxes on time and your state is fully creditable).
– Example credit: $12,000 × 5.4% = $648.
5. Net FUTA tax due = gross FUTA tax − allowable FUTA credit.
– Example net due: $720 − $648 = $72 (effective rate 0.6% on the FUTA wage base).
Practical steps for employers — compliance checklist
1. Determine whether you are required to pay FUTA.
– Review your payroll and employee counts against IRS thresholds (see IRS guidance for current numerical thresholds).
– Check special rules for household and agricultural employers, and for tax-exempt or government employers.
2. Track FUTA-eligible wages by employee throughout the year.
– Monitor wages against the $7,000 per-employee annual cap.
– Exclude exempt payments (fringe benefits, employer retirement contributions, certain family wages, etc.).
3. Calculate gross FUTA tax periodically (quarterly recommended).
– Even if you will file annually, quarterly calculations make it easier to determine whether deposits are required.
4. Determine credit eligibility.
– Confirm whether your state unemployment tax payments make you eligible for the maximum 5.4% credit. If your state’s unemployment program is not creditable for the full amount, your net FUTA rate may be higher.
5. Deposit FUTA taxes (if required).
– If your FUTA tax liability is $500 or more for the year, you must deposit at least once per quarter. The IRS allows you to accumulate smaller quarterly amounts (< $500) and remit them with your annual return.
– All federal tax deposits must be made electronically (EFTPS or other IRS-authorized methods). Check current IRS deposit rules and deadlines.
6. File Form 940 annually.
– Use Form 940 to report annual FUTA wages, calculate gross FUTA tax, report allowable state credits, and show net FUTA tax due or deposited.
– If you deposited FUTA taxes timely during the year when required, you may have a later filing deadline under IRS rules for that year — check the current Form 940 instructions for the exact filing date.
7. Keep payroll records and supporting documentation.
– Maintain wage records, deposit receipts, Forms 940, and state unemployment tax payment documentation for the period required by law (typically several years).
8. If you close the business or stop paying wages, file your final Form 940 and mark it as the final return.
How and when to pay
– Deposit timing: Employers owing $500 or more in FUTA tax for the calendar year must make quarterly deposits. If your accumulated FUTA tax for the quarter is under $500, you may carry it forward to the next quarter.
– Deposit method: Federal tax deposits must be made electronically (e.g., through EFTPS).
– Annual reporting: Employers file Form 940 to reconcile gross FUTA, credits, deposits, and any balance due. The form is filed annually; check current IRS instructions for the precise due date and any extensions allowed for timely depositors.
– Household employers: May report FUTA via Schedule H (Form 1040) instead of Form 940 if they meet household-employer conditions.
FUTA vs. SUTA vs. FICA — how they differ
– FUTA (federal unemployment): Paid only by employers; funds federal administrative costs and helps fund state unemployment insurance programs. Generally 6% on first $7,000 per employee, netting to 0.6% for employers receiving the full state credit.
– SUTA (state unemployment): State-level unemployment taxes; rates, wage bases, and experience-rating rules vary by state. SUTA payments are usually required to obtain the FUTA credit.
– FICA (Federal Insurance Contributions Act): Social Security and Medicare taxes; split between employer and employee (employers match employee contributions). FICA taxes are distinct from FUTA and SUTA.
Common pitfalls and practical tips
– Don’t withhold FUTA from employee pay — FUTA is employer-paid only.
– Keep state unemployment tax payments timely and well-documented to preserve the up-to-5.4% FUTA credit.
– Reconcile employee wage caps carefully — the $7,000 FUTA base is per employee per calendar year, not per quarter.
– If you change business structure or acquire/merge with another business, verify how FUTA liability transfers or is assigned.
– Use payroll software or work with a payroll provider/accountant to automate calculations and deposits and reduce mistakes.
– Always check current IRS and state guidance for updated thresholds, wage bases, and filing deadlines — rules occasionally change.
Example calculation (simple)
– Employee A wages in year: $10,000 → FUTA wages capped at $7,000.
– Employee B wages in year: $5,000 → FUTA wages = $5,000.
– Total FUTA wages = $12,000.
– Gross FUTA = $12,000 × 6.0% = $720.
– If eligible for full state credit (5.4%): credit = $12,000 × 5.4% = $648.
– Net FUTA due = $720 − $648 = $72.
When to get professional help
– If you operate in multiple states, have unusual pay arrangements, or employ household or agricultural workers, consult a payroll specialist or tax advisor.
– If you have questions about whether an organization is exempt or whether your state payments qualify for the full FUTA credit, contact your state unemployment agency or an accountant.
Where to find authoritative guidance and forms
– Investopedia overview of FUTA (background and explanations): https://www.investopedia.com/terms/f/federal-unemployment-tax-act-futa.asp
– IRS FUTA and Form 940 information and instructions:
– General FUTA guidance and Form 940: https://www.irs.gov/businesses/small-businesses-self-employed/futa-tax-and-form-940
– About Form 940: https://www.irs.gov/forms-pubs/about-form-940
– State workforce/unemployment agencies: check your state’s website for SUTA rates, wage bases, filing rules, and payment methods.
Bottom line
FUTA is a federal employer-only payroll tax designed to fund unemployment programs. Compliance requires tracking per-employee wages up to the $7,000 wage base, calculating gross tax at 6.0%, applying applicable state credits (up to 5.4%), making deposits if required, and filing Form 940 annually. Staying organized, paying state unemployment taxes on time, and keeping good records will minimize your FUTA liability and help you avoid penalties.
If you’d like, I can:
– Provide a printable step-by-step employer checklist tailored to your business size (sole proprietor, small business, household employer, or farm).
– Walk through a customized example using your payroll numbers to show the exact FUTA liability and deposit schedule.