Federal Unemployment Tax Act (FUTA): Definition & Overview

KEY TAKEAWAYS

• The Federal Unemployment Tax Act (FUTA) is a nationwide payroll tax that employers must pay to the federal government.
• The revenue that is raised from FUTA is used to fund unemployment compensation.
• The effective FUTA tax rate for most employees is currently at 0.6%.
• It is calculated on the first $7,000 paid to each employee annually.

What Is the Federal Unemployment Tax Act (FUTA)?

The Federal Unemployment Tax Act (FUTA) is United States legislation that imposes a payroll tax on any business that has employees. The revenue that is generated from it is allocated to state employment insurance agencies. From here, it is then used to fund unemployment benefits for people who find themselves out of work. 

FUTA differs from other payroll taxes, such as the Social Security tax. This is because FUTA is paid only by employers whereas the Social Security tax is paid by both employers and their employees.

What Is the Current FUTA Tax Rate?

FUTA taxes have shifted over the years. But the basic FUTA rate is currently 6%. However, any companies that pay state unemployment insurance can get access to a federal FUTA tax credit of up to 5.4%. This could potentially bring the FUTA liability down to as low as 0.6%. 

How Is FUTA Tax Calculated?

The FUTA tax rate is currently set at 6%. Most employers typically receive a credit for up to 5.4%, resulting in the final FUTA rate of 0.6%.  The tax applies to the first $7,000 of wages to employees during the calendar year. This $7,000 is often referred to as the FUTA wage base or as the federal wage. 

So for example, if an employee makes $20,000 – then the first $7,000 will be taxed at 6%. 

6% of $7,000 = $420

So for example, if an employee makes $20,000 – then the first $7,000 will be taxed at this 0.6% rate after the 5.4% credit. 

0.6% of $7,000 = $42

So for example, if an employee makes $20,000 – then the first $7,000 will be taxed at 6%. 

6% of $7,000 = $420

Who Needs to Pay FUTA Tax?

Any employer who has paid $1,500 or more in wages during any calendar quarter must pay FUTA tax. This is on the first $7,000 of wages for each employee per year. Anything that goes beyond this threshold is non-taxable. 

Any employer that has hired one or more workers for at least part of a day, for 20 or more weeks in a single year must pay the FUTA tax. 

Different laws—the general test, the home employees test, and the farmworkers employees test determines who is exempt from paying the FUTA tax. Most employers must pay FUTA tax and apply for the general test. Only those employers that paid less than $1,500 in compensation to an employee during a calendar quarter or who had no employees for 20 weeks or more during the previous calendar year are exempt from paying FUTA.

According to the household employees test, a business must pay FUTA tax if it pays a household employee $1,000 or more in a calendar quarter. Any person who performs household tasks for a private residence, fraternity, or sorority is considered a household employee.

Different rules apply to certain groups, including:

• Household employees who provide household work for private homes, college clubs, and college fraternities and sororities
• Agricultural workers
• Indian Tribal governments and any subsidiaries that are wholly owned by the tribe
• Government employers at the state and local level 
• Some non-profit organizations. In order to qualify for FUTA exemption, non-profits must request and receive 501(c)(3) status from the IRS. Qualifying non-profits are  typically public charities that donate money directly to causes like religion, humanities, education, etc. While some nonprofit organizations are free from FUTA, others must pay the additional unemployment tax.

How Often Do You Pay FUTA Tax?

FUTA tax is calculated on a quarterly basis and paid via a quarterly payment.

Only the first $7,000 an employee makes is subject to FUTA tax. A company may deduct up to 5.4 percent of the money paid into state unemployment programs from its FUTA tax. This results in the FUTA tax rate being 0.6 percent following the credit.

Each employee’s wages up to $7,000 paid in the quarter should be multiplied by 0.6 percent to determine this tax. The net quarterly FUTA tax you owe the government is determined by adding up all of the amounts. At the conclusion of the calendar quarter, this sum is payable on the last day of the month.

You are obligated to make the FUTA liability deposit only if it’s more than $500 for the quarter. 

For example, if your liability is $300 for the first quarter and $400 for the second quarter, you don’t have to pay a deposit for the first quarter but you will have to pay $700 in the second quarter. 

FUTA liability deposits are made electronically through EFTPS.gov. Even if your tax liability is below $500 and you don’t need to make a FUTA deposit, you still need to submit a 940 tax form to the IRS every quarter.

State Unemployment Taxes (SUTA) vs. FUTA

The Federal Unemployment Tax Act, usually known as FUTA, is the federal equivalent of the state taxes known as SUTA that are paid at the state level. The federal government oversees the state-run individual unemployment insurance systems through a fund that receives money from FUTA levies. A state may even borrow from FUTA funds to assist in providing benefits for unemployed persons in their state when it is essential during periods of high unemployment.

A business that pays SUTA can actually lessen the burden of its FUTA. With the 5.4% unemployment insurance federal tax credit mentioned earlier, companies could end up only paying $42 in FUTA per employee per calendar year.

Summary

The Federal Unemployment Tax Act (FUTA) imposes a payroll tax on any business that employs one or more employees and pays them at least $1,500 per year.  FUTA also applies to any business that has employees for at least 20 calendar weeks. All of the revenue that is made from this tax is then put back into the system to fund unemployment benefits for anyone that is out of work. 

If you have employees working for your business, make sure that you are meeting your FUTA obligations.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.