DEFINITION of 'Federal Unemployment Tax Act - FUTA'

The Federal Unemployment Tax Act (FUTA) is the original legislation that allows the government to tax businesses with employees for the purpose of collecting revenue that is then allocated to state unemployment agencies and paid to unemployed workers who are eligible to claim unemployment insurance. The Federal Unemployment Tax Act requires employers to file IRS Form 940 annually in conjunction with paying this tax.

BREAKING DOWN 'Federal Unemployment Tax Act - FUTA'

The Federal Unemployment Tax Act (FUTA) is a federal provision that regulates the allocation of the costs of administering the unemployment insurance and job service programs in every state. As directed by the Act, employers are required to pay federal and/or state unemployment taxes which are used to fund the unemployment account of the government. The funds in the account are used for unemployment compensation payment to workers who have lost their jobs. Although 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 employee wages. This way, FUTA tax differs from Social Security tax which is applied to both employer and employee.

A business owes federal unemployment taxes if it paid at least $1,000 in wages during any calendar quarter in the current or previous year. (A calendar quarter is January through March, April through June, July through September, or October through December). The amount of an employer's FUTA tax liability determines when the tax must be paid, and IRS Form 940 which is used for reporting the tax is due in the first quarter of the year. As of 2018, the FUTA tax rate was 6% of the first $7,000 paid to each employee annually. This means that if a company had 10 employees, each of whom earned wages of at least $7,000 for the year, the company's annual FUTA tax would be 0.06 x ($7,000 x 10) = $4,200. Once an employee’s year-to-date (YTD) wages exceed $7,000, an employer stops paying FUTA for that employee. Therefore, the maximum amount an employer pays in this tax is $420 per employee.

Many states collect an additional unemployment tax from employers. Employers can take a tax credit of up to 5.4% of taxable income if they pay state unemployment taxes. 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 the federal unemployment tax do not qualify for the FUTA credit.

Wages an employer pays to his or her spouse, child under the age of 21, or parent do not count as FUTA wages. Furthermore, 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 federal unemployment tax.

RELATED TERMS
  1. Structural Unemployment

    Structural unemployment is a longer-lasting form of unemployment ...
  2. Payroll Tax

    A payroll tax is a tax an employer withholds from an employee's ...
  3. Taxable Wage Base

    The taxable wage base is the maximum amount of earned income ...
  4. Severance Pay

    Severance pay is compensation given to an employee who has been ...
  5. Termination of Employment

    Termination of employment refers to the end of an employee’s ...
  6. IRS Publication 926

    A document published by the Internal Revenue Service (IRS) that ...
Related Articles
  1. Taxes

    Have Household Help? Don't Get In Tax Trouble

    Hiring household workers can be a complicated process. Know what the government requires so you can prevent penalties and problems down the road.
  2. Insights

    The Cost of Unemployment to the Economy

    Unemployment carries many costs, both obvious and hidden, for an economy.
  3. Financial Advisor

    How Labor Force Participation Rate Affects U.S. Unemployment

    While a falling unemployment rate sounds like a good thing, it can actually be indicative of people leaving the labor force because they can't find a job.
  4. Investing

    How inflation and unemployment are related

    How can inflation affect unemployment, and vice versa? Here, we examine the relationship between wage inflation, consumer prices, and unemployment.
  5. Taxes

    Do Canadians Really Pay More Taxes Than Americans?

    We look at the difference in tax rates and services offered on both sides of the border.
  6. Retirement

    Employers: Don't Forget IRS Form 941

    Use Form 941 to report employment taxes on your business.
  7. Financial Advisor

    Life Insurance Plans to Help Your Small Business Retain Employees

    How to use and design cash value life insurance plans as an incentive to help attract and retain key employees.
  8. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  9. Taxes

    Who Does The Current Tax Code Benefit?

    Are the non-workers benefiting from the current tax code in any way or is it the wealthy who are still getting the big breaks?
RELATED FAQS
  1. Are Cafeteria plans subject to FICA, ERISA or FUTA?

    Find out whether cafeteria plans are subject to ERISA, what they offer to employees and which benefits are subject to FICA ... Read Answer >>
  2. What is the difference between structural unemployment and cyclical unemployment?

    Learn more about about the differences between structural and cyclical unemployment and when cyclical unemployment becomes ... Read Answer >>
  3. What is the difference between frictional unemployment and structural unemployment?

    Learn about structural unemployment and frictional unemployment, the differences between the two and their main characteristics. Read Answer >>
  4. What's the difference between cyclical unemployment and seasonal unemployment?

    Learn about the key differences between cyclical and seasonal unemployment. Read about distinguishing features of each of ... Read Answer >>
Trading Center