What — another acronym from the IRS? If you’re a small business owner, you’ll run into a bunch of these when it comes time to run payroll. But don’t worry: by the end of this article, you’ll know exactly what FUTA is, how to handle it, and why it’s important to your business and your employees.
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What is FUTA? Key points to know
- The standard FUTA tax rate is 6% on the first $7,000 of each employee’s annual wages which means employers pay a maximum of $420 per employee per year
- Employers receive a 5.4% credit (in most states) for paying state unemployment insurance taxes on time and this lowers the effective FUTA rate to just 0.6%
- California and New York currently have lower FUTA credits due to outstanding federal loans, raising their effective rates to 1.2% vs the standard 0.6%
- FUTA taxes are paid quarterly and reported annually on IRS Form 940, which is due on January 31, along with a potential 10-day extension for timely filers
You’ll also know your FUTA from your FICA and SUTA, so payroll will feel a lot less like alphabet soup! And don’t worry, we’ve always got your back if you have any other questions about calculating payroll. In this guide, we will explain how the FUTA tax works, who pays it, and what it is used for.
What is FUTA tax?
The Federal Unemployment Tax Act (FUTA) is a payroll tax that’s used to help fund unemployment benefits. If you have employees, you are required to pay FUTA taxes to the IRS, but you won’t withhold anything from your employee’s paychecks to do so. Instead, you’ll simply pay the FUTA tax to the IRS on behalf of your employees. Let’s dig into the specifics.
What is the purpose of FUTA taxes?
As with all taxes, the goal of FUTA tax is to fund state or federal government spending programs. Specifically, FUTA funds a social welfare program called unemployment insurance, which offers temporary financial assistance to employees who have lost their jobs.
When employees get fired or laid off from their jobs, they can apply for unemployment benefits to help cover their living expenses while they search for new employment. The goal of FUTA is to help ensure that people who have lost their jobs due to unfortunate circumstances can continue paying their bills and funding their lives.
What is the FUTA tax rate?
The standard FUTA tax rate is 6.0% on the first $7,000 of taxable wages per employee, which means that the maximum tax that you as an employer have to pay per employee for the 2023 and 2024 tax year is:
$7,000 x 6% = $420
Once an employee makes $7,000 in gross wages for the year — that’s it. It means you’ve met your FUTA liability and are no longer required to pay FUTA for this particular employee.
Did you know?
In practice, most employers are only responsible for paying a portion of the 6% FUTA rate. We’ll cover more of the details further in the article.
What goes into paying FUTA taxes to the IRS?
Once you’ve calculated the amount of FUTA tax you owe, it’s time to pay the IRS.
Employers are responsible for paying FUTA tax on a quarterly basis, and the payment due date is one month after the end of each quarter. For example, taxes for the quarter ending December 31st are due on January 31st. You can make quarterly FUTA payments directly through the Electronic Federal Tax Payment System.
Businesses also have to report FUTA taxes as part of their annual tax return, filed using IRS Form 940. The due date for filing Form 940 each year is January 31st of the following year. However, if you’ve been good and deposited all of your FUTA tax on time each quarter, you automatically receive a ten-day filing extension.
How often is FUTA tax paid?
The FUTA tax is typically paid to the US government on a quarterly basis, in the month following the end of each quarter. Employers (or their tax preparers, if applicable) should use the IRS’s EFTPS (Electronic Federal Tax Payment System) website to pay any FUTA taxes owed electronically. Here are the quarterly deadlines to make FUTA payments by:
- 1st quarter (January to March): due by April 30th.
- 2nd quarter (April to June): due by July 31st.
- 3rd quarter (July to September): due by October 31st.
- 4th quarter (October to December): due by January 31st of the following year.
If all of this payroll lingo is making you feel a little dizzy, don’t worry, we’ve got you covered. Because there’s so much to keep track of, we created a glossary with many common terms and payroll acronyms you’re bound to come across as a small business owner.
Who is responsible for paying FUTA taxes?
Employers are responsible for paying FUTA taxes on behalf of their employees. Unlike other payroll taxes, no portion of the FUTA tax is withheld from the employee’s paycheck. Instead, the employer simply calculates and pays the tax on their own.
Luckily, the FUTA tax only comes out to about $42 per employee (except for California and New York, which are $84 per employee). This might not sound like a lot, but for a large company with many employees, it can get expensive. And with almost 170 million employees in the United States in 2023 (according to the Bureau of Labor Statistics), that $42 per employee would result in more than $7.1 billion in tax revenue just from the FUTA tax.
Is FUTA withheld from paychecks?
No, unlike other payroll taxes, FUTA is not withheld from employee’s paychecks. Instead, employers are responsible for calculating and paying the FUTA tax on their own. This is because the goal of FUTA is to raise funds to provide financial assistance to people who have lost their jobs.
If the IRS imposed a tax on employees, only to give that tax revenue back to them when they became unemployed, that may not actually help them. Having the employer pay the FUTA tax helps ensure that unemployed people receive new money that they did not already pay to the IRS in the form of taxes.
FUTA tax credit
Here comes some good news… Employers who pay their state unemployment insurance in full and on time are eligible to receive a FUTA tax credit of up to 5.4%, which can result in an effective FUTA tax rate of only 0.6% (6% – 5.4% = 0.6%).
Since you get a whopping 90% discount on your FUTA bill, it pays to be diligent when remitting your state unemployment insurance on time.
But there’s just one little caveat: You’ll notice that we said “up to” 5.4%. The percentage you get back will depend on which state you do business in, and whether your state has any outstanding federal unemployment insurance loans, which are loans that the federal government offers to states to help them afford their unemployment insurance payments.
The Department of Labor announces at the end of each year which states are eligible to receive the full 5.4% tax credit.
For the 2023 tax year, 48 states plus the District of Columbia are eligible for the full 5.4% tax credit.
These states have an adjusted FUTA tax credit of 4.5% for 2024
The 2024 FUTA tax credit (5.4%) is reduced by 0.9% for employers in California and New York. Employers in these states will have a credit of 4.5%, for an effective rate of 1.5%. The wage base of $7,000 means these employers can pay as much as $105 per employee for FUTA.
FUTA credit reduction states for 2023
Remember the caveat we touched upon above? Currently, California and New York both have overdue unemployment insurance loans, and Uncle Sam is keeping an eye out for payment. Because the loans are past due, each was assessed a FUTA credit reduction for 2023 and lost part of the 5.4% tax credit. For employers in these credit reduction states, it means they had higher payroll costs for 2023. As we mentioned earlier, generally, the standard effective tax rate is 0.6%. But with the credit change, the effective rate increased to 1.2%.
For employers in the newly-reclassified credit reduction states, it means they had higher payroll costs in 2023.As we mentioned earlier, generally, the standard effective tax rate is 0.6%. But with the credit change, the effective rate is now 0.12%.
But with the additional 0.3% reduction of this tax credit, along with the initial 0.3% reduction still in place from 2022, the effective post-credit FUTA tax rate for New York and California employers is double that of other states in 2023, coming in at 1.2%, compared to the standard 0.6%.
Here’s what the before and after look like after the adjustment to the credit reduction.
Before: Employers paid up to $42 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
- Or $7,000 x 0.6 = $42
After: Employers may pay up to $84 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
- Or $7,000 x .12 = $84
It means that employers had to pay an additional $42 per employee at the end of the year.
Next, let’s look at where these states stand on their overdue loans.
FUTA credit reduction states for 2024
Fast-forward to 2024, and the Department of Labor has shared that employers in California and New York will again be assessed a FUTA credit reduction for past-due loans. This time, though, the effective tax rate is increasing to 1.5% on the first $7,000 wages paid to each employee — or $105 per employee.
This is a 0.3% increase from 2023 (when the effective rate was 1.2%).
Let’s see how this affects the numbers.
Tax year 2023
Before: Employers in California and New York would pay up to $84 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
- Or $7,000 x .012 = $84
Tax year 2024
After: Employers may pay up to $105 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
- Or $7,000 x .015 = $105
So, what’s the cause? Many states borrowed heavily from the federal government during the COVID-19 pandemic to fund the uptick in unemployment claims. States that have a standing balance with the federal unemployment tax account are assessed a credit reduction.
- January 1 for two (2) consecutive years
- November 10 of the year the reduction is assessed
Though uncommon, this scenario is currently playing out in both California and New York, resulting in higher payroll costs for employers. This is the third year in a row both NY and CA have been assessed a credit reduction.
If you’re a business owner in one of these states and unsure about your obligations due to the credit reduction (or how to account for it on Form 940), it’s a good idea to reach out to your accountant or tax professional to understand the implications for your company.
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What if you are self-employed?
What happens if you’re self-employed? Are you liable for the FUTA tax? The short answer is no, you’re not on the hook to pay FUTA if you’re self-employed. On the other hand, you also aren’t eligible to receive unemployment benefits.
FUTA is just a small part of a small business’s payroll tax journey. If you would like to learn more about the entire process, check out our step-by-step guide here. If you ever have any questions, or feel like you might want to leave this item on your to-do list to someone else, we make payroll really easy. Take a peek.
Please note all material in this article is for educational purposes only and does not constitute tax or legal advice. You should always contact a qualified tax, legal or financial professional, in your area for comprehensive tax or legal advice.
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Erin Ellison is the former Content Marketing Manager for OnPay. She has more than 15 years of writing experience, is a former small business owner, and has managed payroll, scheduling, and HR for more than 75 employees. She lives and works in Atlanta.