FUTA: Federal Unemployment Tax Act

August 25, 2024 4 min read Economics Government Regulations Employment Taxation Government Policy Workforce Unemployment

The Federal Unemployment Tax Act (FUTA) imposes a federal employer tax used to help fund state workforce agencies and unemployment benefits.

On this page

The Federal Unemployment Tax Act (FUTA) is a federal law that imposes a payroll tax on employers. This tax is used to fund state unemployment insurance programs and provide for the payment of unemployment compensation to workers who have lost their jobs.

Overview of FUTA

Definition and Purpose

The Federal Unemployment Tax Act (FUTA) was enacted in 1939 as part of the larger Social Security Act to provide revenue for the U.S. federal government’s role in the administration of unemployment insurance (UI) programs. FUTA is codified in the Internal Revenue Code at Title 26, subtitle C, chapter 23. Employers are taxed on the first $7,000 of wages paid to each employee in a calendar year.

Tax Rate

The FUTA tax rate is currently 6.0%, but employers can receive a credit of up to 5.4% for timely payments of state unemployment taxes, resulting in a net effective rate as low as 0.6%. This credit system ensures that states have adequate funds to pay unemployment insurance benefits.

Mechanism of FUTA

Calculations and Payments

Employers are responsible for calculating their FUTA liabilities and remitting payments to the IRS. The tax is reported annually on IRS Form 940, which is due January 31st for the preceding calendar year. Employers must file and pay any remaining FUTA tax by this date.

States’ Role

Although FUTA is a federal tax, much of its provision and benefits are administered at the state level. States independently collect state unemployment taxes, determine the eligibility for unemployment benefits, and set their own benefits amounts.

Historical Context

Evolution of Unemployment Insurance

Before the establishment of FUTA, there was no nationwide system for unemployment insurance. The Great Depression highlighted the need for a financial safety net for unemployed workers. Following its enactment, FUTA has been amended several times to address economic changes and policy priorities.

Applicability

Who Must Pay FUTA?

Generally, employers who pay wages of $1,500 or more in any calendar quarter, or who employ one or more employees on any day of 20 or more different weeks, must pay FUTA. Non-profits, schools, and government entities may have different requirements.

Special Considerations

Certain wages are exempt from FUTA tax, including but not limited to:

Wages paid to a deceased employee’s estate.
Payments to certain family members.
Fringe benefits such as employee discounts.

Examples

Example 1: A small business with three employees each making $40,000 annually would calculate their FUTA liabilities on the first $7,000 of wages per employee: (3 employees) $\times$ ($7,000) $\times$ 0.6% = $126 in FUTA tax.

Example 2: A corporation with 50 employees, each earning above $7,000, would owe: (50 employees) $\times$ ($7,000) $\times$ 0.6% = $2,100 in FUTA tax.

Comparison with State Unemployment Insurance (SUI)

While FUTA is a federal tax, State Unemployment Insurance (SUI) is imposed at the state level. SUI tax rates and wage bases vary by state and are often higher than FUTA. Both taxes aim to finance unemployment insurance but operate under distinct regulations and reporting procedures.

Payroll Taxes: Taxes imposed on employers or employees, and are usually calculated as a percentage of the salaries that employers pay their staff.
Unemployment Insurance (UI): A government program that provides temporary financial assistance to unemployed workers who are actively seeking employment.
IRS Form 940: The tax form filed with the IRS to report annual FUTA tax owed by employers.

FAQs

What constitutes taxable wages under FUTA?

Taxable wages under FUTA include all payments for services performed by an employee unless specifically exempted. This encompasses salaries, bonuses, and non-cash payments such as goods or services.

How can employers reduce their FUTA tax liability?

Employers can receive a credit of up to 5.4% against their FUTA tax for paying state unemployment taxes on time. Additionally, careful workforce planning and managing exempt wages can reduce overall FUTA liability.

Are there penalties for late FUTA tax payments?

Yes, penalties and interest apply for late payments of FUTA taxes. It is crucial for employers to adhere to deadlines to avoid additional costs.

References

Internal Revenue Service. (2024). Publication 15 (Circular E), Employer’s Tax Guide.
U.S. Department of Labor. (2024). Employment and Training Administration: Unemployment Insurance.

Summary

The Federal Unemployment Tax Act (FUTA) plays an instrumental role in the U.S. socio-economic landscape by ensuring a federal-state partnership in the provision of unemployment benefits. Through employer contributions and administrative guidance, FUTA helps mitigate financial distress for displaced workers, thereby contributing to economic stability and workforce resilience. Understanding the details and requirements of FUTA allows businesses to comply effectively and manage their tax liabilities wisely.

$$$$