What Is the 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.
Understanding the Federal Unemployment Tax Act (FUTA)
The Federal Unemployment Tax Act (FUTA) is a federal provision that regulates the allocation of the costs to administer 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 Federal Unemployment Tax Act (FUTA) is the original legislation that allows the government to tax businesses with employees to collect revenue then allocated to state unemployment agencies and paid to eligible unemployed workers.
- As of 2020, the FUTA tax rate was 6% of the first $7,000 paid to each employee annually.
- While FUTA payroll tax is based on employees' wages, it is imposed on employers only, not their employees.
- FUTA requires employers to file IRS Form 940 annually in conjunction with paying this tax.
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 2020, 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 state unemployment taxes do not qualify for the FUTA credit.
Wages an employer pays to their spouse, a child under the age of 21, or parents 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.