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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 how to handle FUTA and why it’s important to your business and your employees.
You’ll also know your FUTA from your FICA and SUTA, so payroll will feel a lot less like alphabet soup! We’ve always got your back if you have any other questions about calculating payroll.
What is the FUTA tax?
The Federal Unemployment Tax Act (FUTA) is a payroll tax that’s used to fund unemployment benefits. If you have employees, you are required to pay FUTA to the IRS, but you won’t withhold anything from your employee’s paychecks to do so. Next, we’ll dig into the specifics.
What is the 2022-2023 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 2022 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, however, 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. 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 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 on 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.
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.
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 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.
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 2022 tax year, 46 states plus the District of Columbia are eligible for the full 5.4% tax credit.
If you would like to learn more about the FUTA tax credit and the state loan program, you can find a very detailed (and clear, we might add) explanation from the IRS.
FUTA Credit Reduction states for 2022
Remember the caveat we touched upon above? Currently, California, Connecticut, Illinois, and New York all have overdue unemployment insurance loans, and Uncle Sam is keeping an eye out for payment. Because the loans are past due, each has been assessed a FUTA credit reduction for 2022 and has lost part of the 5.4% tax credit.
For employers in the newly-reclassified credit reduction states, it means they will have higher payroll costs in 2022. As we mentioned earlier, generally, the standard effective tax rate is 0.6%. But with the credit change, the effective rate is now 0.9%
Here’s what the before and after look like after the adjustment to the credit reduction.
Before: employers would pay up to $42 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
Or $7000 x 0.6% = $42
After: employers may pay up to $63 per employee in FUTA taxes (when applied to the federal unemployment-taxable wage base).
Or $7000 x 0.9% = $63
It means that employers will see an additional $21 per employee that they have to pay at the end of the year.
So, what’s the cause? Many states have borrowed heavily from the federal government in recent years to fund the uptick in unemployment claims due to the Covid-19 pandemic. For a state to be assessed a credit reduction, it must have a standing balance with the federal unemployment tax account on:
- 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 some states, resulting in higher payroll costs for employers in California, Connecticut, Illinois, and New York.
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.
One last note on credit reduction states: The state of Illinois has announced plans to pay off its debt to avoid another credit reduction in 2023.
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OnPay makes it simple to process bi-weekly payroll for our full-time and part-time employees, while also providing peace of mind that related taxes are properly managed. Their payroll software saves us a lot of time and frees our team up to focus on other responsibilities.
— Les Lance, Life Solutions Insurance Agency, LLC
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.