When running any business with employees, you must understand the ins and outs of payroll tax. If you’re a small business owner starting to hire employees, you’re already familiar with payroll taxes like Medicare and Social Security. But you might be responsible for another tax: the Federal Unemployment Tax Act (FUTA) tax.
What you’ll learn
What you’ll learn
Key takeaways
- The 2025 FUTA tax rate is 6.0% on the first $7,000 of each employee’s wages, with the possibility of receiving a credit reduction of up to 5.4% based on your State Unemployment Tax Act (SUTA) payments
- If your business is eligible for FUTA tax, the law requires you to report and file FUTA annually using Form 940.
- While FUTA is based on employee wages, it’s only imposed on employers
- Some businesses and payments are exempt from the FUTA tax
FUTA is a federal law that requires all employers to pay a tax on workers’ wages to fund the unemployment compensation program. This tax offers temporary financial help to workers who lose their jobs due to circumstances beyond their control. Unlike other payroll taxes, which are split between employers and employees, only employers pay for FUTA. That said, some employers are exempt from the FUTA tax.
Basic subjectivity to FUTA tax
Any company with employees is likely subject to the FUTA tax. However, different organizations have specific tax requirements. According to the IRS, you must pay FUTA taxes if any of the following conditions exist:
- You paid $1,500 or more in wages to employees during any calendar quarter in the current or previous year.
- You had at least one employee (full-time, part-time, or temporary) during some part of a day, in 20 or more different weeks throughout the year. If your business is a partnership, partners are exempt as they are not considered employees.
- You’re a household employer (you hire a babysitter, gardener, nanny, housekeeper) and pay $1,000 or more in cash wages in any calendar quarter of the tax year.
- You’re an agricultural employer who:
- pays farm employees $20,000 or more in cash in any calendar quarter.
- employs 10 or more farmworkers during some part of the day, even if not simultaneously, during any 20 or more different weeks.
| Business type | Subject to FUTA? | Threshold |
| General business | Yes | $1,500+ in wages per quarter or 1+ employee in 20+ weeks |
| Agricultural employer | Sometimes | $20,000+ in wages or 10+ employees in 20+ weeks |
| Household employer | Sometimes | $1,000+ in wages per quarter |
| Nonprofit (501(c)(3)) | No | Exempt if not in SUTA |
| Government agency | No | Exempt — covered by state unemployment insurance |
Categories exempt from FUTA
So, who is exempt from the FUTA tax? Although the tax applies to most employers, some types of organizations and employment situations, including those outlined below, may be exempt from it.
- Nonprofit organizations: If they qualify under Section 501(c)(3) of the IRS code and do not participate in SUTA, nonprofits are exempt from the FUTA tax. Such organizations may include charitable, religious, educational, and certain healthcare institutions. Nonprofits such as social welfare organizations that don’t qualify for Section 501(c)(3) may still be subject to the FUTA tax.
- State and local governments: The federal law exempts states and local government agencies from FUTA taxes. Entities like schools, police departments, municipal offices, and other government-operated institutions are exempt. These institutions typically participate in state unemployment programs instead of federal ones.
- Certain agricultural employers: Agricultural businesses are exempt from the FUTA tax if they pay less than $20,000 in cash wages to farmworkers in any calendar quarter. They are also exempt if they have fewer than 10 farmworkers for part of a day in 20 different weeks during the current or previous year. Crossing either threshold may trigger a FUTA tax liability.
- Domestic service employers: If you hire domestic workers and pay less than $1,000 in cash wages in any calendar quarter, you’re exempt from the FUTA tax. If you exceed this threshold, you become subject to the FUTA tax and may need to file Form Schedule H with your personal tax return.
- Household employers: This category overlaps with domestic employers, but applies if you hire workers for personal use and not business purposes. This includes hiring someone to clean your home, care for a child, or mow the lawn. If you pay less than $1,000 in a quarter, you are exempt. If you pay more, you must pay the FUTA tax.
- Self-employed individuals: If you’re self-employed without employees, you aren’t required to pay FUTA tax on your earnings. The tax only applies to employers who pay wages to others. However, if you’re self-employed and hire staff who earn qualifying wages, the FUTA tax applies to those employees’ wages.
Impact of exemptions on tax liabilities
Beyond compliance, understanding the FUTA tax exemptions will help you calculate your payroll taxes accurately and manage your overall tax liability. Because the FUTA tax rate is 6% on the first $7,000 of each employee’s wages, an exemption could save you up to $420 per employee annually. However, most employers qualify for a credit of up to 5.4% for paying state unemployment insurance, reducing the effective FUTA tax rate to 0.6%, or just $42 per employee each year.
If you’re trying to calculate payroll taxes accurately, excluding the FUTA tax where exemptions apply will help you avoid overpayment and unnecessary reporting. Failing to apply FUTA tax exemptions correctly can lead to errors in payroll tax reporting, IRS notices, or missed opportunities for tax savings.
Common payroll tax compliance mistakes
Even seasoned employers can make critical errors when handling payroll tax obligations. These mistakes often lead to IRS penalties, overpayment, or incorrect filing, especially if you misunderstand exemptions or unemployment insurance. For an error-free payroll, watch out for the common tax compliance mistakes noted below.
Misclassifying workers
Misclassifying workers can result in incorrect payment of payroll taxes, including FUTA tax and unemployment insurance contributions. One of the most common misclassifications is confusing an employee with an independent contractor. If you mistakenly classify an employee as an independent contractor, you could face up to a $100,000 fine. Always use the IRS guidelines to classify workers appropriately.
Overlooking the FUTA tax exemption
Not all organizations are required to pay the FUTA tax. Some, like 501(c)(3) nonprofits or certain agricultural organizations, qualify for exemption, but many uninformed organizations still pay the FUTA tax. As a result, they miss out on savings.
Misunderstanding wage thresholds
The FUTA tax only applies to the first $7,000 of each employee’s wages. Employers sometimes overpay because they don’t cap their FUTA tax calculations or forget to factor in the unemployment insurance threshold at the state level.
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Not claiming state tax credit
If your business contributes to the state unemployment insurance program, you may be eligible for a FUTA tax credit of up to 5.4%. If you don’t claim the tax credit, you can end up paying more tax than necessary.
Using outdated forms or tax rates
Every tax year, the IRS may update Form 940 and adjust tax rates based on legislation. If you file using the previous year’s guidance, you risk incorrectly computing your obligation and triggering an IRS rejection.
To stay compliant, always download the latest form on the IRS website before preparing your filing. For good measure, confirm the tax rate and credit reduction for your state each year.
Plan your taxes effectively
Staying ahead of payroll tax requirements — from the FUTA tax and unemployment insurance to federal and state income tax withholdings — can be a time-consuming task. However, it doesn’t have to be. With the right tool, you can simplify calculations, ensure timely filings, and avoid costly mistakes.
With OnPay, you can automate how you calculate payroll taxes, apply exemptions correctly, handle Form 940, track state unemployment insurance credits, and stay current with IRS updates. Your payroll processes will remain compliant, even as rules change each year. Try OnPay today to see how we can reduce the administrative burden of handling payroll taxes, thereby allowing you to focus on growing your business.
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.