The Federal Unemployment Tax Act or FUTA is a United States federal tax that is collected from employers and used as unemployment insurance.
As an employer, when you lay off an employee, they end up having no job, sometimes even when they are not at fault. These people can now gain access to unemployment benefits. This includes claiming their unemployment insurance, which can help them financially until they find another job.
Apart from FUTA, there is the State Unemployment Tax Act (SUTA), wherein the tax has to be paid to the state for its own unemployment insurance.
The world economy plummeted during the Great Depression in the 1930s. This economic depression began in the United States, where prices fell and unemployment mounted.
By 1932, almost a quarter of the laborers were unemployed in the US. In 1934, President Franklin D. Roosevelt addressed the severity of this situation and declared that people needed “some safeguard against misfortunes which cannot be wholly eliminated in this man-made world of ours.”
A committee was formed, and they decided to develop an unemployment insurance scheme, as they believed that involuntarily unemployed workers deserved partial wages until they could find another job. This would also help in saving and boosting the economy during recessions.
This lead to the establishment of the Federal Unemployment Tax Act (FUTA) in 1939.
If you are an employee in a company or business, then do not worry. You are not required to pay any tax towards unemployment benefits.
As an employer, you have to pay FUTA tax if your business meets any one of the two criteria below:
- Suppose any one of your employees works at least 20 weeks in a year. They do not have to be full-time workers alone; even part-timers are included in this bracket.
- If you have paid your employees at least $1,500 in any quarter of the year.
You do not have to pay any FUTA tax if your employee is under 21 years of age or if your company is a [501(c)(3) organization.](https://www.501c3.org/what-is-a-501c3/#:~:text=Section%20501(c)(3,foundations%20or%20private%20operating%20foundations.)
The amount of money that you are required to pay as standard FUTA tax rate is 6% on the first $7,000 your employee makes in a calendar year. You do not have to pay FUTA tax for any wages over the $7,000 mark.
Say, for instance,
- An employee of yours earned $6,000 in a year. So you are entitled to pay 6% of $6,000 (0.06 * 6000) which is $360 as tax.
- Assume another employee makes $9,000 a year. You are required to pay 6% only on the first $7,000 that they make. This would be equal to $420 as payable tax, and this is as high as it can go.
Meanwhile, the tax rates under SUTA may vary from state to state, and the wages on which tax is taken may increase from the base of $7,000 as well.
As an employer, you must pay both Federal as well as State unemployment taxes.
Right now, you must be thinking that paying both Federal and State unemployment taxes along with other taxes and also running the day-to-day operations of your business may not be too pocket-friendly. After all, your business is your brainchild, and you only want to see it grow. So, let's give you some good news!
You are eligible for a FUTA tax credit of up to 5.4% if you pay your SUTA unemployment taxes diligently and promptly. This means that your FUTA tax rates can get as low as 0.6%.
The following image may help in giving you a better picture of FUTA tax rates.
However, all that glitters is not gold.
You may not receive the entire 5.4% credit as mentioned above. The amount of FUTA tax credit you receive solely depends on the state in which you run your business and also if the state has any dues or arrears in federal unemployment insurance loans.
A state is named a ‘credit reduction state’ if they take a loan from the federal government to use it as their state unemployment insurance and do not repay the loan in the given time. Once a state gets this title, 0.3% is reduced from the tax credits every year.
Most states clear their dues regularly, and employers receive the entire tax credit. However, this is not the case during recessions and pandemics, as unemployment soars during these times.
Let us assume that you have three people, Paul, Kathy, and Brendon, working for you in your company for this sample FUTA tax calculation. Two of them are full-time workers, and one is a part-timer. Let us also assume that you get your total tax credit of 5.4%.
The first step is to calculate the taxable wages of all your employees by adding and subtracting the various fringe benefits. The fringe benefits that are taxable or exempted from tax are given in the instructions for Form 940.
After calculating the taxable wage, let’s say that these wages of your employees are:
- Paul - $20,700
- Kathy - $25,100
- Brendon - $4,800
The amount on which you have to pay FUTA tax will be $18,800. This is because of the $7,000 limit. You only have to pay FUTA taxes on the first $7,000 of Paul and Kathy’s earnings.
7000 + 7000 + 4800 = $18,800
As you have received the entire tax credit, you only have to pay 0.6% (6 - 5.4 = 0.6) on this amount.
FUTA tax = 0.006 * 18800 = $112.8 for one year
The easiest way to pay the FUTA tax due to the Internal Revenue Service (IRS) is through the Electronic Federal Tax Payment System (EFTPS).
All you have to do is enroll with them using your contact information, business information, and bank details to make the transfer.
FUTA taxes are paid quarterly. The deadlines are generally one month after the end of a quarter. This means the four due dates in a calendar year are
- April 30
- July 31
- October 31, and
- January 31 of the following year
However, you may not have to pay these taxes at the end of every quarter. At the end of a quarter, if your FUTA tax liability is less than $500, then you do not have to pay it as this amount gets rolled over to the next quarter.
You only have to pay your FUTA tax if the amount reaches $500 or more, or on January 31 of the following year, whichever comes first.
According to the FUTA tax calculation example shown above, your business only reaches $112.8 a year as it is a small business with only three employees. Therefore, you will have to pay this tax on the 31st of January in the following year.
If you have more employees working for you and collect around $200 as FUTA tax liabilities every quarter, you will have to pay this tax after the third quarter on October 31, as you will cross the $500 threshold.
As a part of your annual tax returns, you also have to report your FUTA taxes to the IRS using Form 940 under the Employer’s Annual Federal Unemployment Tax Return.
Through this form, you let the IRS know how much money you paid in unemployment taxes in a year or how much you still have to pay them if you have not reached that $500 limit.
You can take a look at Form 940 for 2020 to fully understand what details are required from you when you fill out this form.
The due date for filing Form 940 is January 31 of the following year. However, just like Santa Claus, the IRS rewards you if you have been good. If you have paid your FUTA taxes on time and do not have any dues, you get a 10-day cushion for filing it, which pushes the deadline to February 10.
Most of the time, you would only have to pay 0.6% of your employees' income as FUTA tax. If your business is small with a few employees only, then the total FUTA tax liability might not even be much. So, do not forget to pay them promptly and always make sure that you diligently make the entries into your books to keep them balanced.
If you feel overburdened by your business' finances, you can always reach out to an industry-leading bookkeeping service like Fincent. Good luck!