Most people are familiar with unemployment benefits, particularly anyone who’s ever been laid off. But what some new employers may not realize is that they are responsible for funding the program via payroll taxes (FUTA and SUTA). Understanding how these taxes work is essential for business owners hiring their first employee.
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What is FUTA in payroll?
FUTA, or Federal Unemployment Tax Act, supports the state unemployment programs that provide partial wage replacement to unemployed workers. To be eligible for benefits, former employees must be out of work due to circumstances beyond their control. Common examples include layoffs, furloughs, quitting for good cause and terminations for any reason other than misconduct. They must also meet state requirements for wages earned or time worked and actively seek new employment while receiving benefits.
What is SUTA?
Although unemployment insurance is a federal program, it's operated at the state level. This provision, known as the State Unemployment Tax Act (SUTA), allows each state to determine its own benefit and tax structure. Employee eligibility, tax rates, taxable wage bases and the amount of time employers have to respond to claims may all vary by jurisdiction as a result.
How do FUTA and SUTA collectively work?
FUTA helps finance state unemployment insurance via loans. If a state lacks the resources to pay insurance benefits for its residents, it may borrow from the FUTA trust fund. States that do not repay the loan within a certain time frame are known as credit reduction states.
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Compare PackagesWho pays FUTA taxes?
Only employers pay FUTA taxes. As such, they do not withhold federal unemployment from their employees’ gross wages. This rule also applies to SUTA in most cases, excluding New Jersey, Pennsylvania and Alaska. Those states require both employers and employees help fund the state unemployment program.
Who is exempt from paying FUTA taxes?
Most employers pay FUTA unless they meet either of the two exemption criteria outlined in the IRS general test:
- The employer paid less than $1,500 to employees during any quarter of the previous two tax years
- The employer did not employ any people for at least some part of a day in any 20 or more different weeks during the previous two tax years (counting all full-time, part-time and temporary workers)
Different tests apply to household and agricultural employees. Employers should refer to IRS Publication 15, (Circular E), Employer's Tax Guide for more information.
Nonprofit organizations that meet the definition of a charitable organization under Internal Revenue Code (IRC) section 501(c)(3) are also exempt from FUTA.
What is the FUTA tax rate and limit?
The FUTA tax is 6% with a $7,000 wage base limit. In other words, employers pay 6% of the first $7,000 paid to each employee annually. The SUTA wage base may differ, depending on the state.
Employers may be eligible for a 5.4% credit, effectively reducing the FUTA tax rate to 0.6%. To qualify, their state unemployment taxes must be paid in full by the time their Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return is due. They must also not be in a credit reduction state.
How to calculate FUTA tax liability
An employer’s FUTA tax responsibility can be calculated every pay period by multiplying each employee’s gross, taxable wages by 6% until the wage base limit is reached. Annually, the total due per employee is $420 ($7,000 x 0.06). In states where the maximum FUTA tax credit is available, the total liability decreases to $42 per employee, per year ($7,000 x 0.006).
Paying FUTA tax
Due dates for paying FUTA depend on an employer’s total tax liability per quarter as follows:
- If the total due in FUTA exceeds $500 in a single quarter, employers must pay the IRS by the last day of the month following the end of the quarter, e.g., April 30 for the first quarter.
- If tax liability is less than $500, employers carry the balance forward to each subsequent quarter until they owe $500 or more in cumulative federal unemployment taxes.
- If FUTA dues are less than $500 annually, employers may pay their taxes when filing Form 940 at the end of the year.
Payments may be made using the Electronic Federal Tax Payment System.
Reporting FUTA tax
FUTA tax is reported annually using Form 940. The filing deadline is January 31, though employers who paid all their FUTA taxes on time throughout the year may be eligible for an extension until February 10. Forms can be filed electronically or by mail.
Note: Employers in credit reduction states usually must pay additional federal unemployment tax when filing Form 940.
FUTA vs. FICA
Employers must not confuse FUTA with the Federal Insurance Contribution Act (FICA), which funds Medicare and Social Security. Aside from their intended purposes, FUTA and FICA have very different implications for payroll. Only employers pay FUTA, whereas both employers and employees share the FICA tax liability. The employee portion is paid via payroll deductions, which means employers must withhold Social Security and Medicare taxes from employee wages according to the applicable rates.
Frequently asked questions about FUTA in payroll
When are FUTA taxes due?
FUTA taxes exceeding $500 in a quarter are due by the last day of the month following the quarter. If the FUTA liability is less than $500 annually, employers may pay their dues when filing Form 940 at year’s end.
Are household employees subject to FUTA?
Household employees do not pay FUTA taxes, but their employers might. According to the IRS, employers with household employees are subject to FUTA if they pay total cash wages of $1,000 or more to a household employee in any quarter of a tax year.
Do the self-employed pay FUTA?
Sole proprietors do not pay federal unemployment tax because they don’t have employees. If the business is a partnership, partners do not count as employees when applying the IRS general test to determine FUTA liability.
Are FUTA and UI the same thing?
UI or unemployment insurance broadly refers to the partial income replacement benefits that eligible employees may receive if they lose their jobs through no fault of their own. FUTA is the federal tax act that helps fund unemployment insurance programs administered at the state level.
How much is FUTA?
FUTA is a maximum of $42 per employee, per year for employers who pay their state unemployment taxes on time and are not in a credit reduction state. This total is the product of a 0.6% tax on the first $7,000 paid to an employee.
What is a credit reduction state?
States that borrow from the federal unemployment trust fund and do not repay the loans by the appointed date receive a credit reduction. Employers in these states are not eligible for the 0.6% FUTA rate and may have to pay the full 6% to the federal government, in addition to their state unemployment taxes.
How can my business get a FUTA tax credit?
Employers may be eligible for a FUTA tax credit if their state unemployment tax payments are timely, though circumstances are not entirely within their control. If they pay taxes in a state that has outstanding unemployment insurance loans with the federal government, they generally cannot receive the maximum 5.4% credit.
Are nonprofit organizations required to pay FUTA taxes?
Nonprofit organizations may be exempt from FUTA if they are also exempt from income tax. Exemption status ultimately depends on whether the organization meets the definition of a charitable organization under Internal Revenue Code (IRC) section 501(c)(3). Employers should consult a tax professional or attorney to help determine their exemption status.
Do employees pay FUTA tax?
Employees do not pay federal unemployment tax, and employers should not withhold it from their employees’ wages.
This guide is intended to be used as a starting point in analyzing payroll FUTA and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
