What Is the Federal Unemployment Tax Act (FUTA)?

The Federal Unemployment Tax Act (FUTA) is a federal law that imposes an additional tax on employers on top of existing federal income and payroll taxes. The money raised through FUTA is allocated to state unemployment insurance agencies, which fund unemployment benefits for individuals who are out of work.

FUTA taxes are only paid by employers, which means individual taxpayers are not responsible for paying them. The FUTA tax rate is 6% and only applies to a certain dollar figure paid to employees during the year.

Understanding the Federal Unemployment Tax Act (FUTA)

FUTA is a federal law that raises revenue to administer unemployment insurance and job service programs in every state. As directed by the Act, employers are required to pay annual or quarterly federal unemployment taxes; they make up a part of what is commonly known as payroll taxes.

The tax rate is 6%. According to the Internal Revenue Service (IRS), the "tax applies to the first $7,000 you paid to each employee as wages during the year. The $7,000 is often referred to as the federal or FUTA wage base. Your state wage base may be different based on the respective state’s rules."

The funds in the account are used for unemployment compensation payments to workers who have lost their jobs. Although the amount of the FUTA payroll tax is based on employees' wages, it is imposed on employers only, not their employees. In other words, it is not deducted from a worker's wages. As such, FUTA differs from other payroll taxes such as the Social Security tax, which applies to both employers and employees.

How to Calculate FUTA Tax Liability

A company's FUTA tax liability is fairly straightforward to calculate. A company is subject to FUTA taxes on the first $7,000 of payments made to an employee excluding exempt payments. The FUTA tax rate is 6%, and employers often receive a credit of up to 5.4% against this tax.

Suppose that Employee A was paid $10,000 in wages subject to FUTA taxes while Employee B was paid $5,000 in wages subject to FUTA taxes—both in the first quarter. Regarding Employee A, only the first $7,000 of wages per quarter are subject to the tax. Therefore, the tax liability is: FUTA Liability = (Employee A's Eligible Wages + Employee B's Eligible Wages) x 6% FUTA Liability = ($7,000 + $5,000) x $6%

The company's FUTA tax liability would be $720. Note that the company may be eligible for a tax credit of $648 ($12,000 x 5.4%); if this is the case, the company would only owe $72.

Who Pays the FUTA Tax?

The reporting requirements for FUTA vary on the underlying entity that is remitting the taxes to the IRS. FUTA taxes can be paid annually or quarterly, and the amount of an employer's FUTA tax liability determines when the tax must be paid. Here are the different reporting requirements for various types of entities or employers.

Businesses

According to the IRS, a business owes FUTA if it meets one of two requirements. There are two broad measurements to determine whether a business must collect and remit FUTA, and a company only needs to satisfy one of the two following conditions in order to be required to remit FUTA:

1. It paid at least $1,500 in wages during any calendar quarter in the current or previous year.
2. It had at least one full-time, part-time, or temporary employee for at least some part of a day in any 20 or more different weeks in the current or previous year.

Household Employers

There is a different set of reporting requirements for household employers, those who hire a nanny, babysitter, maid, housekeeper, or other people to provide services within one's private home. Household employers must pay FUTA tax on wages if the following two conditions are met:

1. Cash wages of $1,000 or more were paid to a household employee in any quarter during the year.
2. The household employee performs household work in a private home, local college club, or local chapter of a college fraternity.

Household employers can opt to file and report FUTA taxes using Schedule H via Form 1040 instead of Form 940.

Agricultural Employers

Another varying set of requirements exists for agricultural or farming employers. If the employer meets either of the conditions below, they are subject to FUTA tax collection and reporting:

1. Cash wages of $20,000 or more were paid to farmworkers during any calendar quarter during the year.
2. Ten or more farmworkers were employed during some part of the day during any 20 or more varying weeks within a calendar year.
   

Other Employers

Indian tribal governments are exempt from the FUTA tax. However, the tribe must have participated in the state unemployment system for the entire year and be compliant with prevailing unemployment laws. Religious, educational, scientific, charitable, or other tax-exempt organizations are also exempt from FUTA. Services performed by state or local government parties are also exempt.

How to Pay and Report FUTA Taxes

There are two components to FUTA: depositing FUTA taxes and filing the appropriate tax form. Companies that owe $500 or more of FUTA in a calendar year must make at least one quarterly payment. The IRS permits any single quarterly tax liability of less than $500 to be rolled to the next period.

FUTA must usually be deposited at the end of the month after quarter-end. For example, with the first quarter ending March 31, FUTA taxes in Q1 are due for deposit by April 30. The IRS also requires all federal tax deposits to be made via electronic funds transfer.

The tax form is often due in full early in the calendar year. Form 940 is considered to be on time as long as it is properly addressed and postmarked before the due date.

FUTA can be reported via Form 940 electronically using the IRS' electronic filing platform. Taxpayers wanting to mail in a paper form will have varying mailing addresses based on the state they are in.

Federal Unemployment Tax Act (FUTA) vs. State Unemployment Tax Act (SUTA)

Many states collect an additional unemployment tax from employers as per the State Unemployment Tax Act. The SUTA taxes range from 0% to 18.78% of an employee's wages.

Paying SUTA taxes can lessen the burden of FUTA taxes. As noted above, employers can take a tax credit of up to 5.4% of taxable income if they pay state unemployment taxes in full and on time. This amount is deducted from the amount of employee federal unemployment taxes owed.

An employer that qualifies for the highest credit will have a net tax rate of 0.6% (calculated as 6% minus 5.4%). Thus, the minimum amount an employer can pay in FUTA tax is $42 per employee. However, companies that are exempt from state unemployment taxes do not qualify for the FUTA credit.

Federal Unemployment Tax Act (FUTA) vs. Federal Insurance Contribution Act (FICA)

While FUTA is used to fund unemployment benefits, Federal Insurance Contribution Act (FICA) taxes are different in several ways. FICA taxes are paid by both the employer and the employee. The tax is split evenly between the two, though self-employed individuals are usually responsible for both portions.

FICA is intended to fund different government programs. These taxes are used to provide Social Security and Medicare benefits. It is automatically deducted from employee paychecks, and federal law dictates that it is furnished by workers and their employers.

Special Considerations

Wages that an employer pays to their spouse, a child under the age of 21, or parents do not count as FUTA wages. Payments such as fringe benefits, group term life insurance benefits, and employer contributions to employee retirement accounts are not included in the tax calculation for the federal unemployment tax.

Form 940 can be amended for a previous year. When the prior year's information needs to be updated, the IRS requests using the subsequent year to reflect the change.

Various authorized personnel are allowed to sign Form 940 and remit the reporting of FUTA taxes. In general, a business owner, president, vice president, principal officer, fiduciary overseeing an estate, authorized partner, or officer knowing the affairs of a company may be allowed to sign the form.

The Bottom Line

The Federal Unemployment Tax Act (FUTA) is only imposed on employers—not employees. This means that, as an employee, you don't have to pay this additional tax. Taxes collected through the Federal Unemployment Tax Act are used to fund unemployment insurance programs along with those collected by individual states.