Paying taxes is an obligation business owners need to fulfill, often on a monthly, quarterly, and yearly basis. The long-term success of every business depends in large part on managing taxes and one employment tax that employers need to pay close attention to is FUTA.
The Federal Unemployment Tax Act (FUTA) is a federal law that requires employers to pay a certain amount of money annually or quarterly to fund unemployment benefits for employees who lose their jobs. Most businesses also have to comply with State Unemployment Tax Act (SUTA) which serves the same purpose in each state and coordinates with the federal tax.
While Social Security and Medicare taxes are withheld from employees’ paychecks, this is not the case with federal or state unemployment taxes. Instead, both the federal government and state governments collect unemployment taxes from employers only.
2020 FUTA Tax Rate
According to the IRS, the FUTA tax rate is projected to be 6% for 2020. It applies to the first $7,000 paid to each employee as wages during the year. This $7,000 is known as the taxable wage base.
After the first $7,000 in annual wages, employers do not have to pay federal unemployment taxes. Therefore, to calculate the FUTA tax for an employee who receives $6,000 in annual wages, they would multiply 6,000 by 0.06 to get $360. For an employee who receives more than the $7,000 in annual wages, employers should perform the same calculation to get $420, which is the maximum they would pay in FUTA taxes for any single employee.
Not all payments to employees are included in the annual wage used to calculate FUTA tax responsibility. Generally, gross wages, most fringe benefits, and certain employer contributions to employee retirement plans are included in calculation and this total is subject to the 6% FUTA tax rate.
FUTA Tax Credit
Employers who pay their state unemployment insurance on time are eligible to receive a FUTA tax credit of up to 5.4%, which can result in an effective FUTA tax rate of 0.6%. The percentage employers get back depends on which state they do business in and whether that state has any outstanding federal unemployment insurance loans.
If a state has not repaid money it borrowed from the federal government to cover its unemployment benefits liability, it may be classified as 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 Department of Labor determines the credit reduction states each year. By the end of 2019, only the Virgin Islands had past-due loan balances due to the Federal Unemployment Trust Fund. As a result, its employers were subject to a higher FUTA tax rate.Find out how to collect and file taxes successfully while ensuring compliance with federal and state regulations with this comprehensive guide.
When Are FUTA Taxes Due
Employers are responsible for paying FUTA tax on a quarterly basis. The payment due date is one month after the end of each quarter:
- Quarter 1 (January 1–March 31): Payment is due by April 30,
- Quarter 2 (April 1–June 30): Payment is due by July 31,
- Quarter 3 (July 1–September 30): Payment is due by October 31, and
- Quarter 4 (October 1–December 31): Payment is due by January 31.
In case FUTA tax liability is $500 or less in a quarter, businesses do not need to deposit FUTA taxes at the end of the quarter. Instead, they can carry it forward to the next quarter. Once FUTA tax liability exceeds $500 during a quarter including taxes carried forward from the previous quarter, businesses have to deposit the tax. If total FUTA tax liability for the year is $500 or less, employers can either deposit the amount or pay the tax with their Form 940 by January 31.
Reporting FUTA Taxes
The form used to report FUTA taxes is the IRS Form 940. It has to be filed by January 31 of each year. However, the due date for filing Form 940 and the due date for paying the taxes are different. If employers pay taxes on time, the deadline for filing Form 940 gets extended to the second Monday in February.
Most employers have to pay federal and state unemployment taxes. They can determine if they are required to pay FUTA tax using three tests: the general test, household employee test, and farmworkers test.
According to the general test, employers need to file a Form 940 and pay FUTA tax if their business satisfies any of the following criteria:
- They paid $1,500 or more in wages to employees in the last two calendar years, or
- They had at least one employee for any 20+ weeks in the last two calendar years.
FUTA 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% on taxable compensation up to a fixed amount annually for the Social Security portion and 1.45% of taxable compensation for the Medicare portion. The same amount is paid by the employer and the employee.
Effective Handling of FUTA Tax
One of the obligations employers cannot avoid or afford to ignore is paying taxes. However complicated this may seem, employers can manage taxes in a successful and effective way. Whether they pay FUTA taxes annually or quarterly, it is important to pay them on time and avoid unnecessary penalties ranging from 2% to 25%, depending on how late employers are.
Paying FUTA taxes is straightforward, especially if employees live in the same state where business is located. The process can get complicated when businesses have multiple locations, remote employees, or employees who work in one state while living in another. Either way, outsourcing payroll taxes can simplify the entire process. By using the appropriate tax management software employers can automatically calculate, pay and report FUTA while preventing fines caused by inadequate handling of taxes. As a result, businesses can meet necessary deadlines, prevent calculation errors, and avoid penalties for non-compliance.Outsource payroll taxes to ensure accuracy when fulfilling tax obligations and save yourself from potential penalties.