What is the Federal Unemployment Tax Act (FUTA)?

- Updated on Aug 12, 2020 - 08 PM by 123PayStubs Team

The Federal Unemployment Tax Act (FUTA) is the law that requires employers to pay payroll taxes that provides unemployment compensation to workers who have lost their jobs. The FUTA tax is calculated based on employee wages, and there is no deduction from the employee's paycheck. It is the employer who is responsible for withholding and depositing taxes on time. Employers report FUTA tax by filing an annual Form 940 with the IRS.

Understanding the Federal Unemployment Tax Act (FUTA)

Federal Unemployment Tax Act (FUTA) taxes funds the unemployment insurance and job service program available in each state. The funds provide compensation for workers who lose their jobs. Though FUTA tax is a payroll tax, it is different from the FICA taxes in the sense that only the employer contributes toward the FUTA taxes.

No amount is deducted from an employee's paycheck towards FUTA taxes.

FUTA tax is used to fund the following:

  • Share of the federal government cost of unemployment programs with all the states.
  • The unemployment program of the states.
  • The unemployed workers who are eligible to claim their unemployment insurance.

The Federal Unemployment Tax Act (FUTA) requires the employers to pay the FUTA taxes quarterly and report the same on Form 940 annually.

FUTA Tax Rates and Taxable Wage Base Limit for 2020

The FUTA tax rate protection for 2020 is 6% as per the IRS standards. The FUTA tax applies to the first $7,000 of wages paid to each employee throughout the year.

The first $7,000 for each employee will be the taxable wage base limit for FUTA.

Once an employee’s year to date gross earning reaches $7,000 for the year, then the employer can stop paying FUTA tax.

How to calculate FUTA Tax?

  • FUTA Tax per employee = (Taxable Wage Base Limit) x (FUTA Tax Rate).
  • With the Taxable Wage Base Limit at $7,000,
  • FUTA Tax per employee = $7,000 x 6% (0.06) = $420

Consider an employer having 10 employees. Let’s see how to calculate the FUTA tax.

  • FUTA Tax Rate = 6% (0.06)
  • Number of Employees = 10
  • FUTA Tax per employee = $7,000 x 6% (0.06) = $420
  • The FUTA tax for the employer will be $4,200. [($7,000 x 10) x $0.06]

FUTA Tax Credit

The maximum FUTA tax credit is 5.4%. If the employer is eligible for the maximum credit, it means that the tax rate will be only 0.6% i.e: 6% minus 5.4%.

The employers can claim this maximum credit of 5.4% if they satisfy both the conditions below:

  • Paid state unemployment taxes on time in full
  • Not operating under the state that has any outstanding federal unemployment insurance loans

An employer who qualifies for the full tax credit will have a tax rate of 0.6%. This results in the minimum amount of FUTA tax of $42 per employee.

Credit Reduction States

Department of Labor will list those states under “Credit Reduction States”.

  • The employers under credit reduction state are usually not eligible for the full credit against the FUTA tax rate.
  • The employers in these states may have to pay more unemployment taxes for each employee unless the state has repaid its loan.
  • The Department of Labor makes an announcement at the end of each year with the list of states that are eligible to receive the full 5.4% tax credit on FUTA tax.

Virgin Islands is yet to repay its loan balance, so employers in this jurisdiction are potentially subject to a reduction in FUTA.

When is FUTA Tax due?

Usually, the FUTA tax payments are due by the end of the last month following the end of the quarter. The employer has to make the payments to the IRS on time.

  • For Quarter 1 (January to March), the FUTA Tax Payment is due by April 30.
  • For Quarter 2 (April to June), the FUTA Tax Payment is due by July 31.
  • For Quarter 3 (July to September), the FUTA Tax Payment is due by October 31.
  • For Quarter 4 (October to December), the FUTA Tax Payment is due by January 31.

Note: If the FUTA tax liability of your business for a quarter is less than $500, there’s no need to deposit taxes at the end of the quarter. You may roll over the tax liability to the next quarter and pay the tax amount if the liability exceeds the $500 threshold.

Reporting FUTA Tax on Form 940

The IRS mandates employers to report the FUTA tax on Form 940, Employer’s Annual Federal Unemployment Tax Return. The form is used to report to the IRS the FUTA taxes withheld for the year the payments made each quarter.

Form 940 is due by January 31 every year. In case you have deposited FUTA taxes on time for all quarters, you may file the form by February 10.

Add FUTA Taxes to Employee Pay Stubs

You may choose to add FUTA taxes paid for an employee in their pay stubs. With 123PayStubs, you can easily add the employer-paid taxes such as FUTA, SUTA, and other state-specific employer-paid taxes to the pay stubs, along with accurate tax calculations. Click here to know how to add FUTA taxes to pay stubs.

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