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Takeaway
The Federal Unemployment Tax Act (FUTA) helps generate funding for unemployment benefits. These benefits help financially support individuals who abruptly lose their jobs. However, FUTA creates a tax that also affects a majority of employers in the U.S. Read how FUTA taxes work, how FUTA tax liability is calculated and how businesses use the IRS Form 940 to pay and file their FUTA taxes.
Unemployment benefits are a lifeline for people who abruptly lose their jobs. As of May 2024, the national unemployment rate hovers at 3.9%, according to the Bureau of Labor Statistics. In other words, 6.5 million Americans could potentially rely on or qualify for unemployment insurance.
But funding for these programs doesn’t appear out of nowhere. The source? The Federal Unemployment Tax Act (FUTA), a law that requires employers to fund state unemployment benefits alongside their preexisting payroll taxes.
Let’s explore how this crucial law works, the current FUTA rates and how your organization can comply with confidence.
What is FUTA?
FUTA generates money for national unemployment programs through taxes imposed on nearly any business with more than one worker. Signed under the Social Security Amendments of 1939, FUTA has been a compliance requirement for organizations nationwide for nearly a century.
Notably, FUTA taxes fall on employers — not their staff. However, FUTA rates must be derived from employees’ wages. Additionally, the IRS doesn’t collect FUTA taxes every pay period or month. Instead, and similar to other employer payroll taxes, FUTA is paid quarterly or annually.
Without FUTA, state unemployment agencies would suffer a significant blow and would likely have to drastically reduce the benefits they provide. While FUTA isn’t necessarily the sole source of funding for state unemployment programs, it creates a meaningful foundation from which they can operate.
2024 FUTA tax rate
The current FUTA tax rate is 6% of the first $7,000 a business pays to an employee each year. Likewise, enterprises and larger employers can expect to pay more FUTA taxes, though their rate per worker won’t change. While the initial $7,000 is known as the “FUTA wage base,” a State Unemployment Tax Act (SUTA) may modify this base.
Plus, employers that pay their federal and state unemployment taxes in full may have the opportunity to earn a tax credit worth up to 5.4% of their FUTA taxable wages. This credit can potentially reduce a company’s FUTA tax burden to just 0.6%. Regardless, businesses must report their FUTA tax through Form 940.
The FUTA tax rate doesn’t change every year. In fact, the net FUTA tax rate has only increased three times since it was established at 0.3% in 1939. Here’s how this rate has shifted over the last century:
| Net FUTA tax rate since 1939 | |
| 1939 | 0.3% |
| 1965 | 0.4% |
| 1970 | 0.5% |
| 1983 | 0.6% |
When FUTA may change again isn’t clear. Even so, employers should never assume they’re in compliance even with a familiar, long-standing law. Always consult a licensed tax professional to ensure your organization complies with FUTA and any other tax requirement.
FUTA tax requirements
In addition to paying any applicable state unemployment taxes, most businesses must comply with FUTA. Even so, the IRS proposes three tests to help confirm if your business must pay FUTA taxes.
1. General test
Using the general test, employers check if they paid any employees who aren’t household or agricultural workers $1,500 or more in wages during any calendar quarter of the previous or current tax year. Additionally, organizations must verify if they had one or more employees for at least a portion of a day across 20 different weeks during the same time frame.
2. Household employees test
FUTA maintains one primary exception for household workers, which include:
- housekeepers
- babysitters
- gardeners
- and other employees who perform household work at, or upkeep, a private residence
Keep in mind plumbers, renovation specialists and other similar jobs are considered independent contractors, not employees.
Regardless of a household employee’s exact role, their employer may owe FUTA taxes if they were paid more than $1,000 in cash wages in any calendar quarter of the tax year.
3. Agricultural employees (farmworkers) test
While notably laxer than businesses outside of agriculture, farms and other operations within the sector may still be covered by FUTA if a farmworker was paid at least $20,000 during any quarter of the applicable tax year. FUTA my also apply to agricultural organizations that employed at least 10 workers for a portion of the day for at least 20 or more weeks during the tax year.
How do employers calculate FUTA tax?
FUTA tax calculations are derived from the first $7,000 of nonexempt wages paid to a covered employee. FUTA is taken at a rate of 6% — though this may be reduced to 0.6% if the affected employer receives a full, 5.4% FUTA tax credit.
To simplify our example, let’s assume you have two employees and don’t qualify for a tax credit. The first employee made $30,000 in nonexempt wages, whereas the other joined your company late and just earned $4,000. Remember, FUTA will only apply to $7,000 of the first employee’s wages. The second worker’s wages, however, will be covered by FUTA in their entirety.
To determine your hypothetical company’s total FUTA tax liability, we need to combine the covered wages of both employees and multiply it by 6%. This can be framed in the following formula:
FUTA liability = ($7,000 of the first employee’s wages + $4,000, the second employee’s total wages) x 6%
In this scenario, your company’s entire FUTA liability would be $11,000 (the sum of both employees’ eligible wages) multiplied by 6% or $660. Assuming your company did receive a full tax credit of 5.4%, wages could be multiplied by 0.6% instead. Thus, your organization’s FUTA liability would only be $66.
Who is subject to FUTA taxes?
Though employee wages help determine FUTA tax liability, employers are responsible for paying it. FUTA differs from similar acts — like the Social Security Act — which applies to both organizations and their employees. While these laws serve a similar purpose, it might help to consider the unemployment programs that FUTA supports as an emergency fund. Social Security, on the other hand, is often administered as retirement income (excluding those who receive Social Security income for a disability).
How do businesses file for FUTA taxes?
Businesses use IRS Form 940 to pay and file their FUTA taxes for the applicable year. The four-page form requires your company’s:
- employer identification number
- name and trade name (if any)
- address
Employers must also specify if the FUTA tax return is final, amended or relevant at all in the event no wages were paid for the tax year. Employers must also specify if they paid a state unemployment tax and if their FUTA tax liability is impacted by a tax credit.
Afterward, businesses should specify the total wages that were paid to employees, followed by any payments exempt from FUTA. Form 940 also requires confirmation of the total wages paid over the first $7,000 to each employee, even though this amount may not be taxed.
Form 940 then walks employers through adjustments and FUTA tax liability by quarter, which range from:
- Jan. 1 to March 31
- April 1 to June 30
- July 1 to Sept. 30
- Oct. 1 to Dec. 31
You must also provide the name and phone number of any third-party designee — like a payroll provider — that is authorized to speak to the IRS on your behalf.
Finally, Form 940 includes a payment voucher to mail alongside your total tax amount and a notice about the Privacy Act and the Paperwork Reduction Act.
Who is exempt from paying FUTA taxes?
Again, while FUTA covers most businesses, it applies differently to household and agricultural employers. And since Dec. 21, 2000, FUTA taxes don’t apply to tribal entities. However, these businesses may still be subject to taxes applied by state or local unemployment laws. FUTA may also not apply to tax-exempt organizations like charities and religious institutions, as well as state and local government parties.
FUTA vs. SUTA: The difference
FUTA taxes only apply at the federal level, whereas SUTA funds unemployment programs for individual states. Both programs serve a similar purpose and work in tandem to support unemployment initiatives. However, employers and employees may be subject to SUTA taxes. FUTA, on the other hand, only applies to businesses. SUTA taxes may further differ from FUTA in terms of:
- contribution rates
- applicable wage thresholds
- industry-based adjustments
- and more
Consult a local tax professional to verify your company’s exact SUTA liability, especially since this rate may change among the states where you operate. Similarly, exemptions for SUTA may shift on a state-by-state basis.
FUTA: FAQ
How can a business file its FUTA taxes?
Employers covered by FUTA must use IRS Form 940 to pay and file FUTA taxes. This form also helps employers calculate their exact FUTA tax liability and identify any third-party designee.
How can my business get a FUTA tax credit?
Businesses that meet their state and federal tax obligations timely may qualify for a FUTA tax credit. This credit is worth up to 5.4% of the 6% FUTA tax rate, meaning the full tax credit could reduce an employer’s FUTA tax liability to just 0.6%. Consult a licensed tax professional for more information about how your organization may qualify.
Do employees pay FUTA tax?
No. While employee wages help determine a company’s FUTA tax liability, employers are responsible for paying it.
What is the difference between FUTA and Federal Insurance Contributions Act (FICA) tax?
Whereas FUTA taxes fund unemployment benefits, FICA taxes support Social Security and Medicare programs. In other words, FUTA helps provide temporary relief to those who have abruptly lost their jobs. FICA taxes, on the other hand, help support retirees, those who qualify for Medicare and people living with disabilities.
Is FUTA tax deductible?
Yes, FUTA tax can be reduced via a tax credit of up to 5.4%. Employers that believe they qualify for this credit may declare it on their IRS Form 940 as they prepare to pay and file their FUTA taxes.
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