Federal Unemployment Tax Act (FUTA) Explained
TABLE OF CONTENTS
What Is FUTA?
Who Has To Pay FUTA Taxes?
Which Wages Are Not Subject To FUTA Tax?
How To Pay FUTA Taxes
How To Calculate FUTA Taxes
How To File IRS Form 940
Frequently Asked Questions
FUTA Vs. SUTA
FUTA Vs. FICA
Do Self-Employed Individuals Have To Pay FUTA Taxes?
Who Is Authorized To Sign Form 940 For FUTA Taxes?
Key Takeaways:
- FUTA, or the Federal Unemployment Tax Act, is a payroll tax that employers must pay on employee wages to fund the federal unemployment pool.
- The 6% FUTA tax is imposed on the first $7,000 an employee earns.
What Is FUTA?
The Federal Unemployment Tax Act (FUTA) is a law created by the United States government that imposes a payroll tax on employers to fund unemployment programs for workers who have lost their jobs.
By paying FUTA taxes and contributing to unemployment insurance and job service programs across the U.S. states, workers who lose their job can receive unemployment compensation payments to help them afford their living expenses now that they have lost their source of income.
Who Has To Pay FUTA Taxes?
FUTA taxes are imposed on employers, so regular employees do not have to worry about this type of tax. The FUTA tax reporting requirements can vary depending on the tax entity that is remitting tax payments to the IRS, and because FUTA tax payments can be submitted quarterly or annually, an employer’s FUTA tax liability may be due at different times of the year.
Businesses
Businesses are required to pay FUTA taxes if they meet one of two IRS requirements. Business owners who have paid at least $1,500 to their employees during a quarter or who employ at least one full-time, part-time, or temporary worker for at least 20 weeks during the year are responsible for paying FUTA taxes.
Agricultural Employers
Individuals in the farming and agricultural industries must follow their own set of FUTA tax requirements. Agricultural employers must collect and report FUTA taxes if they paid $20,000 or more in wages to their farmworkers during a quarter of the tax year or if they employed ten or more farmworkers during the day for 20 or more weeks within the tax year.
Household Employers
Household employers, or people who hire workers for their home, such as a maid, a housekeeper, a babysitter, or a nanny, must pay FUTA taxes on the wages paid if they meet certain requirements. Household employers will owe FUTA taxes on employee wages if they paid $1,000 or more to their household employee during a single tax quarter or if their household employee provides services in a private home, local chapter of a college fraternity or sorority, or a local college club.
Other Employers
There are FUTA tax exemptions for Indian tribal governments as long as the tribe is compliant with prevailing unemployment laws and has participated in their state’s unemployment system for the entire year. There are other types of organizations that are exempt from FUTA taxes, such as religious organizations, educational organizations, scientific organizations, charitable organizations, and state and local government parties.
Which Wages Are Not Subject To FUTA Tax?
It is beneficial to note that not all payments made by an employer are subject to FUTA tax. For example, if an employer pays wages to their spouse, their parents, or their child who is under the age of 21, they will not be responsible for paying FUTA taxes on that portion of the money paid to their employees. Additionally, payments made toward group term life insurance benefits, employer contributions to employee retirement accounts, and fringe benefits are excluded from the federal unemployment tax calculation.
How To Pay FUTA Taxes
In order to pay FUTA taxes, taxpayers must calculate how much they owe, fill out the appropriate tax forms, and submit the form and payment to the IRS.
When companies owe $500 or more in FUTA taxes, this becomes one of the tax types that are due to the IRS each quarter, so four times a year employers will need to submit their payment. The deadlines for FUTA quarterly tax payments are as follows:
- Quarter 1 (January, February, March): April 30
- Quarter 2 (April, May, June): July 31
- Quarter 3 (July, August, September): October 31
- Quarter 4 (October, November, December): January 31
Failing to submit quarterly payments on time can lead to consequences with the IRS, such as being issued a tax penalty between 2-15%. For this reason, it is important to pay the tax liability on time to avoid unnecessary fees that result in an increased tax bill. Quarterly FUTA tax payments must be paid using the electronic funds transfer on the IRS website.
How To Calculate FUTA Taxes
Employers are responsible for paying FUTA taxes at the tax rate of 6% of the first $7,000 an employee earns during the tax year. Any earnings exceeding $7,000 will not be subject to FUTA taxes. Employers are also often able to claim a FUTA tax credit of up to 5.4% of the employee’s eligible wages paid for during the tax year, which can result in significant savings in their tax liability.
Here are some examples:
- Small business with one employee:
Quarter 1 employee wages: $8,000
FUTA liability: $7,000
FUTA calculation formula: ($7,000) x 6% = $420 FUTA tax payment
Potential FUTA tax credit: ($7,000) x 5.4% = $378 tax credit
Total FUTA tax liability: ($420 FUTA tax) – ($378 tax credit) = $42 final FUTA tax liability
Taxpayers who are eligible to receive the full 5.4% FUTA tax credit will be taxed a 6% FUTA tax rate rather than the 0.6% tax rate.
How To File IRS Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return
While the payments for FUTA taxes are due quarterly, the tax form associated with FUTA taxes, IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, is due early in the calendar year on January 31.
Here are the instructions for how to fill out IRS Form 940 and file FUTA taxes.
Top Of Form
The top section of IRS Form 940 allows the employer to enter all of their business information, including the employer identification number (EIN), name, trade name, and address. In this section they must also indicate which type of return they are filing out of the four options:
a. Amended
b. Successor employer
c. No payments to employees in 2022
d. Final: Business closed or stopped paying wages
Part 1
In Part 1 of IRS Form 940, taxpayers must indicate details about the tax return, including if they had to pay state unemployment tax in one state only, multiple states, or if they had to pay wages in a state that is subject to credit reduction.
Part 2
Part 2 of IRS Form 940 is where employers can input the payroll information related to FUTA taxes, including the total payments to all employees, payments that are exempt from FUTA tax (such as fringe benefits, group-term life insurance, retirement/pension, or dependent care), the total of payments made to each employee in excess of $7,000, the total taxable FUTA wages, and the FUTA tax before adjustments.
Part 3
Part 3 of IRS Form 940 allows employers to determine any applicable adjustments. If all of the taxable FUTA wages paid out to their employees were excluded from the state unemployment tax, they can multiply the total taxable FUTA wages listed on line 7 by 0.054, or 5.4%. If only some of the taxable FUTA wages paid out to employees were excluded from the state unemployment tax, or if any of the state unemployment taxes were paid late, they can just enter the amount from line 7 in this section. Finally, if the FUTA credit reduction applies, they can enter the total on line 11.
Part 4
Part 4 of IRS Form 940 is where taxpayers can consider all of their bookkeeping numbers to determine their FUTA tax, balance due, or overpayment. In the case that the employer overpaid their unemployment tax liability, they can select whether they would like the excess amount credited towards their next tax return or if they’d like to receive the excess funds in the form of a tax refund.
Part 5
Part 5 of the tax form is where employers must report the amount of their FUTA tax liability for each quarter of the year, in addition to their total FUTA tax liability for the year.
Part 6
Part 6 of IRS Form 940 is where the employer can appoint a third-party designee, giving them permission to discuss the tax return with the IRS on their behalf. If they choose to appoint a third-party designee, they will need to report their name, phone number, and a 5-digit personal identification number (PIN).
Part 7
The seventh and final section of IRS Form 940 is where taxpayers must sign and print their name, phone number, and date.
Electronic filing of IRS Form 940 must be submitted before that due date, but forms mailed in person can be considered on time if they are delivered late, as long as the envelope is correctly addressed and has a postmark prior to the deadline.
Frequently Asked Questions
FUTA Vs. SUTA
Both FUTA and SUTA are payroll taxes that are used to fund unemployment programs, but while FUTA is assessed at the federal level, SUTA imposes the collection of state unemployment taxes. Therefore, employers living in certain states will be required to pay both FUTA tax and SUTA tax.
The state unemployment tax rate ranges from 2% to 5% of employee wages, which is lower than the 6% FUTA tax rate.
One of the benefits of paying both FUTA and SUTA tax rates is the opportunity to claim the FUTA tax credit. Eligible employers can claim a tax credit of up to 5.4% of the taxable income if they are compliant in paying their state unemployment taxes on time. If they are eligible for this credit, they can deduct this amount directly from the amount of FUTA taxes they would have owed. Taxpayers who qualify for the highest tax credit rate of 5.4% will only owe a net tax rate of 0.6%.
FUTA Vs. FICA
Taxpayers sometimes confuse different tax concepts with similar names, so FUTA and FICA are often mistaken for one another. These are both federal tax acts, but there are differences in what the tax is applied towards and who has to pay the tax.
While the Federal Unemployment Tax Act (FUTA) is a payroll tax that serves to fund federal unemployment programs, the Federal Insurance Contribution Act (FICA) is a payroll tax used to fund Social Security and Medicare programs.
FUTA taxes are paid by employers, whether they have full-time or part-time employees or if they hire independent contractors. FICA taxes are paid by both employers and employees, and the tax rate is split evenly between the two.
Do Self-Employed Individuals Have To Pay FUTA Taxes?
Self-employed individuals are not required to pay FUTA taxes, and even if they hire independent contractors for their business, they will not owe FUTA taxes on their wages. Furthermore, individuals who are partners will not owe FUTA payments on their distributive share of partnership profits.
Who Is Authorized To Sign Form 940 For FUTA Taxes?
There are several individuals involved in businesses who have the authorization to sign IRS Form 940 to report FUTA taxes. Here is a list of some of these authorized individuals:
- The business owner
- The company president
- The company vice president
- The fiduciary overseeing the estate
- An authorized partner
- A principal officer
- An officer with knowledge of company affairs
It is essential that business owners understand their taxpayer obligations and make organized preparations for when it is time to file and pay taxes. If you have any questions about reporting or paying unemployment taxes, consulting with an experienced tax professional can help you maintain tax compliance and minimize your tax bill. Set up a free consultation with Ideal Tax today to get started.
Luis serves as the Director of Operations for Ideal Tax, overseeing a multifaceted team including case management, tax professionals, document specialists, customer support, training, and development.
