What is FUTA Tax? | A Guide to the Federal Unemployment Tax Act

22nd June 2021

FUTA, or the Federal Unemployment Tax Act, is a policy designed to help states pay unemployment benefits to those whose work contracts have been terminated. But this is only applicable if workers have not been dismissed for gross misconduct.

There are several questions surrounding compliance matters and the various responsibilities of the employer regarding FUTA tax. If you’re a business owner and have staff, even if you only employ a few workers, it’s valuable to understand FUTA, including its current rates, how often it should be paid, and who might be exempt.

What is FUTA Tax?

FUTA is a nationwide payroll tax in the United States. Many employers are obliged to pay both a specific Federal and a state unemployment tax. This tax fund, as the IRS (Internal Revenue Service) observes, is then allocated to pay unemployment compensation to workers who have lost their jobs, unless dismissal resulted from gross misconduct.

While different states might have their own regulations regarding unemployment benefits, sometimes they lack the adequate funds to cover unemployment compensation. In the event that a state needs to borrow money from the Federal government, the FUTA tax fund can supply financial support for unemployment benefits.

Who Needs to Pay FUTA Tax?

Any employers who has paid $1,500 or more in wages during any calendar quarter, must pay FUTA tax on the first $7,000 of wages for each employee per year. Anything beyond this threshold, however, is non-taxable. Unlike taxes under FICA (or the Federal Insurance Contributions Acts), the employer pays this tax rather than the employee.

Any employers that have hired one or more workers for at least part of a day, for 20 or more weeks in one year, must pay FUTA tax.

What is the Current FUTA Tax Rate?

The basic rate of FUTA tax is 6%. However, companies who pay state unemployment insurance can receive a federal tax credit of up to 5.4%. This can bring the current FUTA tax rate down to as low as 0.6%. Applied to the first $7,000 of each employee’s wages only, this equates to just $42 per employee.

This credit rate may not be obtainable if a state has not finished repaying the Federal government after borrowing from the FUTA tax fund to cover unemployment benefits. If a state fails repayment of a Federal loan after two consecutive years, it becomes known as a ‘credit reduction state’.

How Often Do You Pay FUTA Tax?

How often FUTA tax must be paid depends on how many employees you have, and this will determine how much you owe.

FUTA tax is, generally, paid quarterly.

  • If a company’s FUTA tax amounts to more than $500 for the calendar year, they must make at least one quarterly payment.
  • If FUTA tax liability is $500 or less for a quarter, the amount should be carried over into the next quarter until the cumulative liability is more than $500.

Companies that never exceed the $500 figure for the year can pay FUTA tax in their annual tax return.

For those who pay FUTA tax quarterly, the due dates for payment are:

  • April 30th
  • July 31st
  • October 31st
  • January 31st

How to Report FUTA Tax

FUTA tax must be reported using Form 940, or the Employer’s Annual Federal Unemployment Tax Return. This must be completed if the following criteria are met:

  • A company has paid an employee(s) $1,500 or more in any quarter of the current or previous year.
  • A company has hired 1+ employees for any part of a day in 20+ weeks of the current or previous year.

Form 940 must be filed by January 31st of the respective year. For the 2021 tax year, for example, the form should be completed by January 31st 2022.

Who is Exempt from FUTA tax?

Any company that pays less than $1,500 to an employee per quarter does not need to pay FUTA tax.

Additionally, according to the IRS, any company that is exempt from income tax under section 501(c)(3) of the Internal Revenue Code is also exempt from FUTA tax.

Find the details of 501(c)(3) exemption requirements here.

FUTA tax is one of the lesser-known policies in North American employment law. However, during periods such as the coronavirus pandemic, it’s one of the most important. For help understanding how FUTA impacts your payroll, get in touch with the international experts at IRIS FMP Global. For further information regarding US payroll, read on here.