Federal unemployment tax is a payroll tax that employers pay to fund state unemployment insurance programs

Federal Unemployment Tax Act (FUTA) tax is a tax on employers, not employees. Employers pay it to the federal government, which then distributes the money to state unemployment insurance programs. The tax funds the system that pays benefits to workers who lose their jobs through no fault of their own.

The current federal unemployment tax rate is 6% on the first $7,000 of wages paid to each employee per year. However, most employers receive a credit that reduces what they owe. If an employer pays state unemployment tax on time and in full, they can claim a credit of up to 5.4% against their federal tax. This means most employers end up paying 0.6% in federal unemployment tax, though the rate can be higher in certain situations.

The $7,000 wage base resets each calendar year on January 1. This means an employer calculates FUTA tax only on the first $7,000 each employee earns in a calendar year, not on total annual earnings above that amount.

Key Takeaways

  • FUTA tax is paid by employers only, calculated at 6% on the first $7,000 of each employee's annual wages, though most employers pay an effective rate of 0.6% after claiming state tax credits.
  • The federal tax funds the unemployment insurance system that states administer, and the $7,000 wage base resets each January 1.
  • Employers who fail to pay state unemployment tax on time or in full cannot claim the credit and must pay the full 6% federal rate.
  • New employers and those in certain industries may pay a higher federal rate until they establish a history with their state unemployment program.

How the federal rate connects to state unemployment taxes

The federal unemployment tax system is designed to work alongside state unemployment insurance programs. Each state runs its own unemployment insurance fund and sets its own tax rate, which employers pay to the state. The federal FUTA tax exists partly to fund a loan program: when a state's unemployment fund runs low during a recession, the federal government can lend money to that state so it can continue paying benefits.

The credit system creates an incentive for employers to pay their state unemployment taxes. If an employer owes $420 in federal unemployment tax (6% of $7,000) but has paid $378 in state unemployment tax (5.4% of $7,000), they can credit that $378 against the federal amount and pay only $42. If they had not paid the state tax, they would owe the full $420 to the federal government.

State unemployment tax rates vary widely. Some states charge employers as little as 0.5% of payroll, while others charge 5% or more. The rate often depends on the employer's industry, the number of former employees who have filed for benefits, and how long the employer has been in business.

Who must pay federal unemployment tax

Most employers must pay FUTA tax, but there are exceptions. An employer generally must pay FUTA tax if they paid wages of $1,500 or more in any calendar quarter during the current or prior year, or if they had at least one employee for at least some part of a day in any 20 different weeks during the current or prior year.

Certain employers are exempt from FUTA tax. These include the federal government, state and local governments, certain nonprofit organizations, and railroads (which have their own unemployment insurance system). Agricultural employers and household employers have different rules and thresholds.

If an employer is subject to FUTA tax, they must pay it on wages paid to all employees, including part-time workers, temporary workers, and family members. The tax is calculated on gross wages before any deductions for income tax, Social Security, or health insurance.

When federal unemployment tax is due

FUTA tax is calculated quarterly based on wages paid during that quarter. The quarters are January through March, April through June, July through September, and October through December. An employer calculates the tax owed for each quarter and deposits it with the federal government by the due date for that quarter.

Deposits are due on the last day of the month following the end of each quarter. For example, FUTA tax for the first quarter (January through March) is due by April 30. If the due date falls on a weekend or holiday, the deposit is due the next business day.

Most employers deposit FUTA tax electronically through the Electronic Federal Tax Payment System (EFTPS) or through their payroll provider. Some employers may be required to deposit more frequently if they owe a large amount. The IRS provides a schedule each year that specifies deposit requirements.

How federal unemployment tax differs from Social Security and Medicare taxes

FUTA tax is separate from the Social Security and Medicare taxes that employers and employees both pay. Social Security and Medicare taxes are withheld from employee paychecks, while FUTA tax is paid entirely by the employer and does not appear on a worker's pay stub. FUTA tax also applies only to the first $7,000 of each employee's annual wages, whereas Social Security tax applies to a much higher wage base that changes each year.

The purpose is also different. Social Security and Medicare taxes fund those specific programs. FUTA tax funds the unemployment insurance system. An employee who loses their job may receive unemployment benefits from the state program that FUTA tax helps support, but the amount and duration of those benefits depend on state law and the employee's work history, not on how much FUTA tax was paid.

What happens if an employer does not pay federal unemployment tax

Employers who do not pay FUTA tax on time face penalties and interest. The IRS charges interest on unpaid FUTA tax, calculated daily from the due date until the tax is paid. Penalties also explore and can range from 5% to 25% of the unpaid tax, depending on how late the payment is and whether the employer has a history of late payments.

An employer who fails to pay state unemployment tax loses the credit against federal tax. This means they must pay the full 6% federal rate instead of the reduced 0.6% rate. If an employer owes back taxes to both the state and federal government, the IRS may place a lien on the employer's property or garnish bank accounts to collect the debt.

Employers are also required to report FUTA tax information on their annual tax return. The IRS matches this information against deposits made during the year. If deposits do not match the reported amount, the IRS will contact the employer to reconcile the difference.

New employers and higher federal unemployment tax rates

A new employer typically pays a higher federal unemployment tax rate in their first few years of business. This is because the credit against federal tax depends on paying state unemployment tax, and new employers often have a higher state rate until they establish a record with their state's unemployment insurance program.

Some states assign new employers a standard rate that applies for the first few years. Other states use a "new employer rate" that is higher than the average rate for established employers. Once an employer has been in business for several years and has a record of paying state unemployment tax, their state rate may decrease, which in turn lowers their effective federal rate.

Employers in certain industries, such as construction or staffing, may also face higher state unemployment tax rates because workers in those industries file for unemployment benefits more frequently. This higher state rate means a higher credit, but it also means the employer's total unemployment tax burden is higher.

Frequently Asked Questions

Do employees pay federal unemployment tax?

No. FUTA tax is paid only by employers. Employees do not have FUTA tax withheld from their paychecks. Employees do pay Social Security and Medicare taxes, which are separate from unemployment tax.

What is the difference between FUTA and SUTA?

FUTA is the federal unemployment tax paid to the federal government. SUTA (State Unemployment Tax Act) is the state unemployment tax paid to the state. Most employers pay both. The federal tax rate is 6%, but employers who pay state tax on time can credit up to 5.4% against the federal amount.

Can an employer deduct FUTA tax as a business expense?

Yes. FUTA tax is a deductible business expense for federal income tax purposes. An employer can deduct the amount paid during the tax year on their business tax return.

What if an employer has employees in multiple states?

An employer must pay FUTA tax to the federal government on all employees, regardless of which state they work in. The employer must also pay state unemployment tax to each state where they have employees. Each state has its own rate and rules.

How is FUTA tax reported on tax forms?

Employers report FUTA tax on Form 940 (Employer's Annual Federal Unemployment Tax Return), which is filed with the IRS. The form shows total wages paid, the amount of FUTA tax owed, deposits made during the year, and the balance due or refund owed.