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What Is FUTA Tax? Everything Business Owners Should Know

by David Polaski on Dec 30, 2021 10:06:52 AM

If you’re hiring and paying employees for the first time, one of the things you’ll need to manage is calculating and filing payroll taxes. One of these that you’ll more than likely have to pay as an employer is the Federal Unemployment Tax Act (FUTA) tax. That’s because most employers pay both FUTA and a state unemployment tax. But just what is FUTA tax and what do you need to know to comply with its requirements? Let’s find out.

To help you understand your responsibilities when it comes to withholding FUTA tax from your employees’ pay and remitting it to the IRS, here we’ll cover what is FUTA, who pays it, what’s the rate, and how you file. After reading this, you’ll understand what you need to do to pay FUTA tax properly and on time to avoid potential penalties.

What is FUTA tax?

FUTA tax is a payroll tax paid solely by employers on employee wages. Unlike other payroll taxes like Social Security, nothing is deducted from an employee’s pay.

The revenue generated by FUTA tax, along with state unemployment insurance programs, provides for unemployment compensation for workers who lose their jobs through no fault of their own. In addition to FUTA tax, most businesses also pay a state unemployment (SUTA) tax; each state administers a separate unemployment insurance program within guidelines established by federal law. Under this Federal-State Unemployment Compensation Program, the federal government aids states in funding unemployment benefits.

Who is subject to the tax?

In general, most businesses other than those exempted like nonprofits and religious organizations must pay FUTA taxes. Specifically, employers are responsible if they paid wages of $1,500 or more or had at least one employee for some part of a day in 20 or more different weeks in the calendar year. It’s important to note that you don’t pay FUTA tax on independent contractors since they’re not considered employees.

Moreover, there are specific tests to determine if you owe FUTA taxes for household employees or farmworkers. For example, there’s a partial exemption if you paid cash wages of less than $20,000 for agricultural labor during any calendar quarter of the current or preceding year or didn’t employ at least 10 workers for some portion of a day in each of the 20 different weeks during the current or preceding calendar year.

What is the FUTA tax rate?

The FUTA tax rate is currently 6.0%. The federal tax applies to the first $7,000 in wages you pay each employee during a calendar year after subtracting any exempt payments. It’s important to note that all wages paid are counted as FUTA wages so that includes salaries and wages, commissions, bonuses, vacations allowances, sick pay, and contributions to retirement plans.

The good news is that companies can qualify for a tax credit of up to 5.4% based on their timely payment of state unemployment taxes if the state isn’t a credit reduction state. So for these businesses, the rate would be as low as 0.6%. Just be aware that employers in a credit reduction state can’t claim the full credit.

When is the tax due?

When you need to pay FUTA taxes depends on how much you owe, which is driven by how many employees you have. For example, if your tax is more than $500 in any quarter, you need to make a quarterly payment. If your tax is $500 or less, then you carry it over to the next quarter and/or the next until your cumulative tax is more than $500. At that time, you’ll need to deposit your tax for the quarter. If, by the end of the fourth quarter, your FUTA tax is $500 or less, you can either deposit the amount or pay it with Form 940.

The quarterly due dates for FUTA taxes are as follows:

  • Q1 – due April 30
  • Q2 – due July 31
  • Q3 – due October 31
  • Q4 – due January 31

Deposits are made through the Electronic Federal Tax Payment System (EFTPS).

How do you file?

To report annual FUTA tax payments, employers use IRS Form 940. The form must be filed by January 31; however, if you deposited all tax when it was due, then you don’t need to file it until February 10. If this due date falls on a Saturday, Sunday, or legal holiday, then you have until the next business day to file. To file, the form can be mailed or e-filed.

It’s important to file your Form 940 on time or you’ll risk late payment penalties. In fact, the IRS imposes a late filing penalty on the unpaid tax amount that ranges from 2% to 15% depending on when you submit your form.

How to Best Comply with FUTA Tax Requirements

As you can see, there’s a lot to consider when it comes to managing your FUTA tax payments. And FUTA is just one of the payroll taxes you’re responsible for getting right to avoid penalties. To learn the steps to properly withhold and remit these taxes, read our beginner’s guide to payroll taxes.

Editor’s Note: This blog was originally published in October 2021 and has been updated in September 2022 for accuracy.

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