Employer Guide to Federal Unemployment Tax – FUTA
Employers pay the Federal Unemployment Tax (FUTA) 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.
As an employer, you are responsible for paying unemployment taxes to the IRS and making reports to the IRS on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return
How Unemployment Taxes Work
In brief, the unemployment tax system works as follows:
- Employers pay into the system, based on a percentage of total employee wages.
- A portion of the tax is withheld from employee paychecks
- The amount paid goes into a fund which pays unemployment benefits to employees who have been laid off.
- Employees leaving voluntarily do not receive coverage.
Taxes at the State Level
Both the federal government and most state governments collect unemployment taxes. The federal government collects unemployment funds and pays into state funds—known as State Unemployment Tax (SUTA). The federal funds help to supplement what 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, as a business owner, 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.
Federal Payment Requirement
If your business has employees, you must get a Federal Employer ID Number (EIN). This qualifies as the registration for your business and federal unemployment insurance payments.
You must pay unemployment taxes if:
- You paid wages of $1,500 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.
- This does not include contract workers, who are not employees.
Federal Unemployment Tax Payment and Timing
Employers pay federal unemployment tax based on employee wages or salaries. The FUTA tax is 6% (0.060) on the first $7,000 of income for each employee. Most employers receive a maximum credit of up to 5.4% (0.054) against this FUTA tax for allowable state unemployment tax. Consequently, the effective rate works out to 6%.
Compensation Payments 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)
You can find the complete list of payments exempt from FUTA Tax 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 also excluded from state unemployment tax. Check with your state unemployment office types of employee income subjected to FUTA tax.
How to Calculate FUTA
To get a general idea of how much you might need to pay for FUTA taxes, do the following calculation:
Begin with 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 percent (0.08) to get the amount of unemployment tax due.
When FUTA Deposits Are Due
As an employer, you would first calculate the amount of federal unemployment tax for a given period’s payroll, or all of the employee paychecks for a pay period. You would then record an accounting entry to set this amount aside in a payables account.
You would then make payments into the federal unemployment tax fund at the IRS, using the Electronic Federal Tax Payment System. The frequency of payments made depends upon the number of employees and the amount of tax owed.
If your company has a FUTA Tax liability in any one-quarter of more than $500, you must make a deposit by the last day of the month the follows 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. If your liability in Quarter 2 (ending June 30) is $200, your accumulated 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 undeposited amount from any earlier quarter) exceeds $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; you don’t need to make a deposit.