The Federal Unemployment Tax Act (FUTA) is a federal payroll tax that helps fund unemployment benefits.
In response to the COVID-19 economic crisis, most states took action in mid to late 2020 and early 2021 to minimize some of the financial concerns (i.e., increases in SUI tax expenditures) that might affect companies in the calendar year 2021. As a result, most states reduced the taxable wage base last year.
In this article, we will talk about FUTA, its current tax rate and how much you need to pay for FUTA.
What is the Federal Unemployment Tax Act?
The Federal Unemployment Tax Act (FUTA), created in June 1939, was designed to create more jobs for Americans who were suffering during the Great Depression. It is a federal payroll tax that provides temporary unemployment benefits to qualified workers who lose their job through no fault of their own.
The FUTA rate was initially 3% on both employers and employees for each covered worker from 1940 until 1950, when it changed to 0.20% per employee. In 2013, the rates dropped substantially due to economic improvements leading up to 2014.
The Federal Unemployment Tax Act (FUTA) is a United States federal law that establishes a system of unemployment insurance to provide financial assistance to eligible workers who have lost their jobs through no fault of their own. FUTA was enacted in 1939 as part of the Social Security Act and is intended to help stabilize the economy by providing temporary income to individuals who are unemployed while they search for new job opportunities.
Under FUTA, employers are required to pay a tax based on their payrolls to fund the unemployment insurance program. These funds are collected by the federal government and used to provide unemployment benefits to workers who meet certain eligibility criteria. States also have their own unemployment insurance programs, and FUTA provides guidelines and standards for these state programs. Each state administers its own unemployment insurance system, setting its own eligibility criteria, benefit amounts, and duration of benefits within certain federal guidelines.
Employers are typically responsible for paying both state and federal unemployment taxes on behalf of their employees. However, the federal tax rate can be reduced by a credit if the employer’s state program meets certain requirements.
It’s important to note that FUTA is just one component of the larger unemployment insurance system in the United States, with both federal and state components working together to provide financial support to eligible unemployed individuals during times of economic hardship.
Regular Unemployment Insurance (UI) benefits are funded by employer contributions made on behalf of each employee to the state’s UI Trust Fund. Additionally, they pay taxes under the Federal Unemployment Tax Act (FUTA) to the federal government to help with:
- the management of the UI program
- Loans to insolvent states made by UI
- Benefits of federal extension
Information on taxes
California has had an outstanding federal loan balance for two years in a row as a result of the effects of the unprecedented COVID-19 problem. Therefore, California employers will experience an increase in their FUTA taxes on wages provided to their employees in 2022 starting in January 2023. In order to keep our UI fund solvent, California started borrowing money from the federal government on June 3, 2020. California’s anticipated year-end loan balance is projected to reach $19.3 billion by the end of 2022, according to the May 2022 UI Fund Forecast.
Generally, when employers file their Employer’s Annual Federal Unemployment (FUTA) Tax Return (Form 940), federal law allows them to claim a 5.4 percent FUTA tax credit against the 6.0 percent normal tax. For the 2022 tax year, this credit will be lowered by 0.3 percent to 5.1 percent. That results in an additional $21 per employee, per year, for each employer in California. Without any modifications to the state’s UI funding scheme, it is predicted that FUTA expenses will rise by an extra 0.3% annually until the UI Trust Fund becomes solvent. Visit FUTA Credit Reduction on the IRS website for more details.
2022 FUTA tax rate
The standard FUTA rate in 2022 is 6%, with a taxable wage base of $7,000 (per employee) or taxable wages up to $7,000.
This means that an employer’s federal unemployment payroll tax liability is equal to 0.6 % on the first $7,000 paid per worker; however, state unemployment taxes are due as well.
You can pay extras to employees in addition to their income or earnings, such as the cost of meals or housing, some relocation charges, health plans, group life insurance benefits, or 401ks. The Instructions for Form 940 include a detailed list of these “fringe” advantages.
Take note that a person that is part of your workforce is considered as an employee if they are engaged in service to you, and it’s for your business (or trade), whether it’s full or part-time. These are employees that you filed Form W-2 for.
How to calculate Federal Unemployment Tax Act
To compute the FUTA tax on a worker’s annual wages, do the following:
Add up all taxable wages paid to an employee in a calendar year. For example, you pay Employee Jane $7,000 in December 2021 and another $8,500 in January 2022. Add these two amounts together for a total of $15,500.
If during that same period you paid Employee John only $5,000 of wages subject to FUTA taxes, then your total is still $15,500. Multiply the amount by 0.07. In this case, your answer would be $120.00 ($15,500 x 0.07 = 930).
Paying FUTA taxes to the IRS
Typically, employers must deposit their FUTA tax liability to the U.S. Treasury through the Electronic Federal Tax Payment System (EFTPS) or by filling out and mailing in a paper form (Form 940-V).
The business also needs to report FUTA by filing a Form 940 (or 940-EZ) by January 31 of the following year as part of its annual tax returns.
Who needs to pay for FUTA?
Every employer pays FUTA; nothing is taken from the employee’s pay. However, there are a few more standards to complete in order to be considered.
Employee must pay if:
- You pay wages of $1,500 or more (in any calendar quarter) to an employee;
- You have one or more employees working for you on any day in 20 different calendar weeks;
- Or, your employees are scattered over one state within a single calendar year.
Contract workers—those who receive a Form 1099-NEC—are not considered “employees.”
Under the Federal Unemployment Tax Act (FUTA), employers are responsible for paying the FUTA tax. This tax is intended to fund the federal portion of the unemployment insurance program in the United States. Here are some key points about who needs to pay for FUTA:
- Employers: Any employer subject to the federal unemployment tax must pay the FUTA tax. This includes businesses, nonprofit organizations, and government entities that meet certain criteria.
- Employee Wages: FUTA tax is based on the wages paid to employees. As of my last knowledge update in September 2021, the FUTA tax is applied to the first $7,000 of each employee’s wages in a calendar year. This means that if an employee’s wages exceed $7,000 in a year, the employer does not need to pay FUTA tax on the wages above this threshold for that employee.
- Threshold for Liability: In general, employers become liable for paying the FUTA tax if they paid at least $1,500 in wages to employees during any calendar quarter in the current or previous calendar year.
- Tax Rate: The standard FUTA tax rate is 6% of eligible wages, but employers can usually claim a credit of up to 5.4% if they are eligible for and pay their state unemployment taxes on time. This effectively reduces the federal FUTA tax rate to 0.6% for eligible employers.
What is the FUTA tax credit?
A credit of up to 5.4 percent for state unemployment taxes can reduce the FUTA tax owed by employers on their payroll, but only if you are subject to state or local unemployment taxes.
Setting aside Federal Unemployment Tax Act money
To keep track of your FUTA savings, follow these tips:
- Know your quarterly average gross payroll (AGP). Add the total gross wages for all employees in any quarter and divide by 4.
- Calculate the FUTA you owe based on your AGP. Multiply your AGP by 0.7%
- Add this amount to the tax you pay for other employment taxes (state and local unemployment insurance, state workers’ compensation insurance, etc.)
- Deposit or pay any federal non-FUTA taxes as well as FUTA taxes by the deposit schedule or due dates so that you meet all filing requirements.
- Keep records of these calculations to ensure that no interest is charged to you for underpayment of estimated tax because you deposited too little money during the year.
Filing and paying FUTA taxes is a straightforward process, as long as you have a basic understanding of how much you owe and when the payments are due.
Failure to pay FUTA taxes can lead to significant penalties, including fines and even criminal charges. So it’s in your best interest to make sure you’re fulfilling your FUTA requirements and other tax responsibilities on time.
If you need to know more details about FUTA rates, the federal unemployment tax act or how to do your payroll taxes properly, the best way is either reading-related guides online. And if you are not good at that kind of stuff but want to get it done on time, then hiring a professional is probably your best choice.