What is the Federal Unemployment Tax (FUTA)?
When and How to Pay and Report Federal Unemployment Taxes
What is Federal Unemployment Tax?
The Federal Unemployment Tax (FUTA) is paid by employers to fund the unemployment account of the federal government, which pays employees who leave a company involuntarily. Businesses also may have to pay state unemployment taxes, which are coordinated with the federal unemployment tax.
Your responsibility as an employer is to pay unemployment taxes to the IRS and to make reports to the IRS on Form 940.
How Do Unemployment Taxes Work?
The unemployment tax system works like this:
- Employers into the system, based on a percentage of total employee wages
- The amount paid is put into a fund which pays unemployment benefits to employees who have been laid off (not for those who have left voluntarily).
What About State Unemployment Tax?
The federal government and most state governments both collect unemployment taxes. The federal government collects unemployment funds and pays into state funds to supplement funds the states collect.
Many employers pay both federal and state unemployment taxes, depending on what state you are doing business in. To find out if you need to pay state unemployment tax, contact your state's employment agency. If your state collects this tax, you will need to register with your state. The Department of Labor has more information on state unemployment insurance benefits.
How Do I Start With Federal Unemployment Taxes?
If your business has employees, you must get a Federal Employer ID Number (EIN). This is your registration for your business and federal unemployment insurance payments.
You must pay unemployment taxes if:
- You paid wages of $1500 or more to employees in any calendar quarter of a year.
- You have one or more employees for at least some part of a day in 20 or more different weeks during the year. You must count all employees, including full-time, part-time, and temporary workers.
Don't count contract workers, who are not employees.
What is the Amount of Federal Unemployment Tax? How is it Paid and When?
Employers pay federal unemployment tax based on employee wages or salaries. The FUTA tax is 6.0% (0.060) on the first $7000 of income for each employee. Most employers receive a maximum credit of up to 5.4% (0.054) against this FUTA ta for allowable state unemployment tax. So, the effective rate is .6%.
What Payments are Exempt from FUTA Tax?
Some of the payments you make to employees are not included in the tax calculation for federal unemployment tax. These payments include:
- Fringe benefits, such as meals and lodging, contributions to employee health plans, and reimbursements for qualified moving expenses
- Group term life insurance benefits
- Employer contributions to employee retirement accounts (like 401(k) accounts).
The complete list of payments that are exempt from FUTA Tax is available in the instructions for Form 940.
In some states, wages paid to corporate officers, certain payments of sick pay by unions, and certain fringe benefits are excluded from state unemployment tax. Check with your state unemployment office about what employee income is subject to FUTA tax.
How Do I Calculate Federal Unemployment Taxes?
If you want to get a general idea of how much you might need to pay for FUTA taxes, you can do this calculation:
First, you'll need to get the FUTA taxable wages (that is, gross pay of employees), plus:
- Most fringe benefits, including wages and salaries, commissions, fees, bonuses, vacation allowances, sick pay, and the value of goods, lodging, food, and other non-cash benefits,
- Employer contributions to employee retirement plans
From this amount, deduct:
- All payments that are exempt from FUTA tax (see below) and
- All amounts over $7,000 for the year.
Then, take the total amount up to $7,000 for all employees and multiply it by .6% (0.08) to get the amount of unemployment tax due.
When are Federal Unemployment Tax Deposits Due?
First, an employer calculates the amount of federal unemployment tax for a payroll (all of the employee paychecks for a pay period). This amount is set aside in a payables account.
You must make payments into the federal unemployment tax fund at the IRS, using the Electronic Federal Tax Payment System. How often payments are required to be made depends upon the number of employees and the amount of tax owed.
If your company's FUTA Tax liability in any one quarter is more than $500, you must make a deposit by the last day of the month after the end of the quarter.
For example, if your liability in Quarter 1 (ending March 31) is $350, you do not need to make a deposit. but if your liability in Quarter 2 (ending June 30) is $200, your liability is $550, and you must make a deposit by July 31. Since you have made a deposit for Quarters 1 and 2, if your tax liability for Quarter 3 (ending September 30) is under $500, you do not need to make a deposit for the 3rd Quarter.
If your unemployment tax liability at the end of the year is over $500, you must make a deposit by January 31 of the following year or with your Annual Unemployment Tax Report on Form 940.
If your FUTA tax for any of the first three quarters of the year (plus any un-deposited amount from an earlier quarter) is over $500, deposit it by the last day of the month after the end of the quarter. If it is $500 or less, carry it to the next quarter; a deposit is not required.
How are Federal Unemployment Taxes Reported to the IRS?
FUTA taxes are reported annually on Form 940 (Employer's Annual Federal Unemployment (FUTA) Tax Return. How to Complete Form 940.
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