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What is FUTA?

Pay wages of $1,500 or more to employees in a calendar quarter? Then you must pay this tax annually.
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What is FUTA?

The Federal Unemployment Tax Act (FUTA) created a program to help states pay for unemployment benefits for workers who have been terminated (other than for gross misconduct). If you pay wages of $1,500 or more to employees, you must pay this tax annually. This tax is in addition to any state unemployment insurance you may owe.

Basics of FUTA

FUTA is a tax that employers pay to the federal government. Employees do not pay any FUTA tax or have anything subtracted from their paychecks. The tax applies only to the first $7,000 of wages to each employee (other than wages that are exempt from FUTA). This wage threshold has been in effect since 1983, but could be changed by Congress in the future.

There is no FUTA tax for self-employed individuals. Thus, if you are a partner, there is no FUTA on your distributive share of partnership profits. If you engage independent contractors in your business, you don't pay FUTA on payments to them.

The basic FUTA rate is 6 percent. However, you may receive a credit for state unemployment tax of 5.4 percent. This brings the net federal tax rate down to 0.6 percent. Applying this rate to the first $7,000 of wages for each employee results in a tax of up to $42 per employee. There had been a 0.2 percent surtax in effect starting in 1983 but after numerous extensions it ended in 2007.

Note: If a state has not repaid borrowing from the federal government to cover its unemployment benefits liability, it may be a "credit reduction state." This means the amount of the credit for state unemployment tax is reduced and the FUTA rate is effectively increased. The designation of credit reduction states is made by the Department of Labor.

Discrepancies between FUTA and FICA

FUTA, which is for unemployment benefits for employees, should be distinguished from FICA, which is a separate tax paid by both employers and employees to provide Social Security and Medicare benefits. The FICA tax is 6.2 percent on taxable compensation up to a fixed amount annually (e.g., $137,700 in 2020) for the Social Security portion and 1.45 percent of taxable compensation for the Medicare portion (without any limit). The same amount is paid by the employer and the employee. For example, if an employee earns $50,000, the employer's FICA tax is $3,825 (6.2% of $50,000 + 1.45% of $50,000). The employee pays the same $3,825, which is withheld from their wages.

Paying and reporting FUTA

Even though there is an annual reporting for FUTA (explained next), the tax must be deposited at least quarterly if it is more than $500 per quarter. More specifically, if FUTA tax liability is more than $500 for the calendar year, you must deposit at least one quarterly payment. If FUTA tax liability is $500 or less in a quarter, carry it forward to the next quarter and continue to do so until your cumulative FUTA tax liability is more than $500. At that point, you must deposit your FUTA tax for the quarter.

Deposits are made through the Electronic Federal Tax Payment System (EFTPS). If you don't exceed the $500 threshold, you can pay the tax when you file your annual FUTA tax return.

The tax is reported on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The return must be filed if:

  • You paid wages of $1,500 or more to employees in any calendar quarter during the current or previous year.
  • You have one or more employees for at least some part of a day in any 20 or more different weeks in the current or previous year.

Special rules apply to employers of agricultural workers. They are in the Instructions to Form 943.

Form 940 must be filed by January 31 of the year following the year to which it relates (e.g., January 31, 2020, for 2019).

Returns can be mailed or e-filed (the IRS has a list of authorized providers here). If you aren’t sure how to calculate, file, or meet your FUTA obligations, a tax professional can help.

What is the FUTA Tax Rate for 2020?

Thus far in 2020, the FUTA tax rate remains consistent. Consistent with prior years, employers should withhold 6% of the first $7,000 of an employee's wages. The tax credit of up to 5.4% for state unemployment tax (SUI) is also unchanged.

Companies must continue to withhold FUTA if they have paid wages of $1,500 or more in any calendar quarter in 2019 or 2020, or they have paid employees for at least a portion of a day in any 20 weeks in 2019 or 2020. Separate tests are applied toward agricultural workers and household workers.

The recent CARES Act has extended the deadline for the payment of the employer's share of Social Security taxes in 2020, but FUTA deadlines have not changed. The next federal unemployment tax payment due date is July 31st. At this time, FUTA withheld during the second quarter of 2020 that is greater than $500 must be deposited.

The CARES Act also provides an Employee Retention Credit to assist companies who continue to pay wages to employees unable to work during the pandemic. This credit will first be applied to Social Security tax owed. Any excess credit will be refunded to employers.

For additional information on how the CARES Act affects payroll taxes, please visit the Paychex Coronavirus Help Center.

 

barbara weltman
Barbara Weltman is a tax and business attorney and the author of J.K. Lasser's Tax Deductions for Small Business as well as 25 other small business books.
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