If you have employees, staying on top of payroll taxes is part of running a compliant business. One of those obligations is the Federal Unemployment Tax Act, or FUTA, which helps fund unemployment benefits for workers who lose their jobs.
Unlike Social Security or Medicare taxes, FUTA is paid entirely by the employer. It’s a separate responsibility with its own rules, but it plays an important role in supporting the unemployment system. It’s a tax you pay out of pocket — and missing payments or filing incorrectly can result in penalties and interest.
This guide will explain who needs to pay FUTA, how it’s calculated, when it’s due, and how to stay compliant without the process taking up more time than it should.
What is FUTA and how does it work?
The Federal Unemployment Tax Act (FUTA) is a payroll tax that employers pay to support the nation’s unemployment insurance system. Unlike other payroll taxes, such as Social Security and Medicare, FUTA is not deducted from employee wages. It’s paid solely by employers as part of their payroll tax responsibilities.
FUTA taxes help fund:
- State unemployment agencies’ administrative costs.
- Unemployment benefits for eligible workers who lose their jobs.
- Emergency federal unemployment programs during economic downturns.
While states handle most of the unemployment benefit payments, FUTA provides the federal framework and backup funding that keeps these programs running smoothly.
For employers, FUTA compliance is a key part of meeting payroll tax obligations, alongside federal income tax withholding and FICA taxes. Understanding where FUTA fits helps ensure you’re covering all bases and staying compliant.
Who has to pay FUTA (and who doesn’t)?
Most employers are required to pay FUTA taxes. You’re generally required to pay if your business meets either of these conditions:
- You paid $1,500 or more in wages to employees in any calendar quarter this year or last.
- You had at least one employee working part of a day in 20 or more different weeks during the current or prior year.
For context, even a part-time employee working just one day a week could trigger FUTA liability over time. This means most small businesses with regular staff will fall under these rules.
Special Rules for Household and Agricultural Employers
- Household employers (like nannies or housekeepers) must pay FUTA if they paid a household worker $1,000 or more in any calendar quarter.
- Agricultural employers are subject to FUTA if they either:
- Paid $20,000 or more in cash wages to farmworkers in any quarter.
- Employed 10 or more farmworkers during part of a day in 20 or more different weeks in the year.
Common Exemptions
Certain employers are exempt from FUTA, including:
- Nonprofit organizations with 501(c)(3) status.
- Federal, state, and local government entities.
- Federally recognized tribal governments under specific conditions.
If you’re unsure whether your business is required to pay FUTA, the IRS provides detailed guidance in the Instructions for Form 940.
How do I calculate my FUTA taxes without second-guessing myself?
Calculating your FUTA tax correctly ensures you avoid IRS penalties and keeps your payroll tax reporting clean. It’s a straightforward calculation, but there are a few key rules to remember.
Here’s how it works, step by step:
Taxable Wage Base
Only the first $7,000 of wages paid to each employee per year is subject to FUTA tax. Anything earned beyond that is not taxed under FUTA.
Standard Tax Rate
The standard FUTA tax rate is 6.0%.
State Unemployment Tax Credit
Most employers receive a 5.4% credit for paying state unemployment taxes on time, which reduces the effective FUTA rate to 0.6%.
Example Calculation:
Let’s say you have an employee who earns $30,000 in a year:
- FUTA applies only to the first $7,000 of their wages.
- $7,000 x 6.0% = $420 (gross FUTA liability).
- If you qualify for the full 5.4% credit, your effective rate drops to 0.6%.
- $7,000 x 0.6% = $42.
- You’ll pay $42 in FUTA tax for this employee for the year.
Multiply that by your number of employees, and you’ll have a good estimate of your total FUTA liability.
Credit Reduction States:
If your state has borrowed from the federal government to fund unemployment benefits and hasn’t repaid those loans, you might face a credit reduction. This lowers your 5.4% credit, increasing your FUTA tax rate for that year.
Each November, the IRS publishes a list of credit reduction states. Always verify if your state is affected before filing.
How and when do I report and pay FUTA taxes?
Employers report their FUTA tax using IRS Form 940, which covers the entire calendar year. This form is due by January 31 of the following year.
However, payment timing depends on how much you owe throughout the year. Here’s how it works:
- If your total FUTA tax liability exceeds $500 in a calendar quarter, you must make a deposit by the end of the following month.
- If your FUTA liability is less than $500, you can carry it forward to the next quarter. Once your cumulative liability exceeds $500, a deposit is required.
- If your total FUTA tax for the year remains under $500, you can pay the amount in full when you file Form 940.
For all FUTA deposits and payments, the IRS requires you to use the Electronic Federal Tax Payment System (EFTPS). This free and secure platform ensures your payments are properly recorded and provides confirmation receipts for your records.
One of the most common mistakes small businesses make is forgetting to track their cumulative liability, causing them to miss a deposit deadline. EFTPS makes it easier to stay on top of these payments by providing scheduled reminders and a clear transaction history.
Do I need to worry about state unemployment taxes, too?
Yes. In addition to the federal FUTA tax, most employers are also responsible for paying State Unemployment Insurance (SUTA or SUI) taxes. These state-level programs fund unemployment benefits for workers in your specific state, separate from the federal system.
Here’s how FUTA and SUTA work together:
- Paying your state unemployment taxes on time earns you a credit of up to 5.4% on your FUTA tax. This credit significantly reduces your FUTA liability.
- Missing state tax payments or deadlines can reduce or eliminate that credit. If that happens, your FUTA tax rate increases, leading to a larger federal tax bill.
- Some states, known as credit reduction states, may face additional FUTA taxes if they have outstanding federal unemployment loans. This reduces your available credit and increases your effective FUTA rate.
For example, if your state is designated as a credit reduction state, your FUTA credit could drop from 5.4% to 5.1% or lower, increasing your FUTA payments.
Since state unemployment tax rules and rates vary, and credit reduction designations can change yearly, it’s essential to check your state’s specific requirements and deadlines to stay compliant and avoid unnecessary tax costs.
How can I stay FUTA compliant and avoid surprises?
FUTA compliance doesn’t have to be complicated. With the right systems in place, you can stay ahead of deadlines, avoid penalties, and ensure your tax reporting is accurate. Here’s a practical checklist to keep you covered.
Get an Employer Identification Number (EIN)
Before filing FUTA taxes, you’ll need an EIN. This is your business’s federal tax ID number, used for all payroll-related filings.
Maintain Accurate Payroll Records
Track every employee’s wages, hours, and payment dates. Accurate records are essential for correct tax reporting and will save you time (and stress) during audits.
Classify Workers Correctly
Misclassifying employees as independent contractors is a common and costly mistake. Always verify that you’re following IRS guidelines for worker classification to avoid penalties.
File Forms and Pay Taxes on Time
Submit Form 940 by January 31 and make quarterly FUTA deposits when required. Filing and paying early helps you avoid interest charges and late fees.
Address Errors Quickly
If you discover a mistake after filing, you can amend your Form 940. If you’re unable to pay your tax bill on time, contact the IRS promptly to explore payment plans and avoid escalation.
Stay Updated on Federal and State Changes
While FUTA tax rates and wage bases don’t change often, state-level factors can impact your federal tax bill. Credit reduction states, for example, may increase your FUTA liability if they owe federal loans.
Each year, the IRS releases updated Form 940 instructions and publishes a list of credit reduction states. Check for these updates toward the end of the year to avoid surprises.
Consider Professional Help
If payroll taxes aren’t your specialty, working with a payroll service or accountant can save you time and reduce the risk of errors. A professional can help you navigate both federal and state unemployment tax obligations and keep your filings in order.
Staying compliant is easier when you’re proactive. Regular check-ins with your payroll system, staying informed on state-specific changes, and seeking expert advice when needed will keep your business on track.
The bottom line
FUTA compliance is manageable once you understand the basics. Knowing who pays, how much, and when can save you from penalties and unnecessary stress.
Here’s what to keep in mind:
- Only the first $7,000 of wages per employee is taxed.
- Most employers qualify for a credit that reduces FUTA tax from 6.0% to 0.6%.
- File IRS Form 940 by January 31 and make deposits if needed.
- Stay current with state unemployment tax rules, especially credit reduction states.
- Keep accurate payroll records and review filings carefully.
For official guidance, check the IRS Form 940 instructions, EFTPS for payments, and your state’s unemployment tax agency.
If you’d rather not navigate this on your own, our team at DiMercurio Advisors can help. Schedule a free consultation to get clear answers and make sure your FUTA and payroll taxes are handled correctly.
