What is the Federal Unemployment Tax Act (FUTA)?

What is the Federal Unemployment Tax Act (FUTA)?

The Federal Unemployment Tax Act (FUTA) is a United States federal law that imposes a payroll tax on any business with employees. The tax collected is used to fund state workforce agencies and provides unemployment benefits to workers who have lost their jobs. 

FUTA is an employer-only tax, meaning it is not deducted from employee wages but is paid solely by the employer. FUTA can significantly impact a company by influencing its payroll tax responsibilities and contributing to state unemployment funds.

Key features of FUTA

• Employer responsibility. FUTA is exclusively paid by employers; it is not deducted from employee wages.

• Tax rate and base. The standard FUTA tax rate is 6.0% applied to the first $7,000 of each employee’s annual earnings. However, employers can receive a credit of up to 5.4% for timely paid state unemployment taxes, effectively reducing the FUTA rate to 0.6%.

• Fund allocation. The tax collected under FUTA goes into the Unemployment Trust Fund, which the federal government uses to oversee state unemployment agencies and ensure they have adequate funds.

What companies should know

1. Determine Liability. Generally, a business is subject to FUTA taxes if it paid wages of $1,500 or more in any calendar quarter, or had one or more employees for at least some part of a day in 20 different weeks in a year.

2. Understand state requirements. Since FUTA works in conjunction with state unemployment taxes, understanding state-specific requirements is crucial. Employers should ensure they comply with both federal and state unemployment tax regulations.

3. Annual reporting. Employers must report FUTA taxes annually using IRS Form 940. This form reconciles the amount of FUTA tax owed and the amount already paid, along with any state unemployment funds paid.

Actions companies should take

• Regularly review tax rates and credits. Keep informed about current FUTA tax rates and potential credits for which the company might be eligible. This includes understanding how state unemployment tax payments affect FUTA tax credits.

• Maintain accurate records. Accurately track and record all wages paid to employees, as this information is essential for calculating FUTA tax liability.

• Timely payment. Ensure that FUTA tax payments are made on time to avoid penalties and interest. Typically, these taxes are paid quarterly.

• Stay informed on changes. Tax laws can change, so staying updated on these changes, including any adjustments in FUTA rates or requirements, is vital for compliance.

• Seek professional advice. Consider consulting with a tax professional or accountant who can provide guidance specific to your business situation, helping ensure compliance with FUTA and other tax obligations.

Key considerations for companies

• Ensure compliance with FUTA to avoid penalties and fines.

• Keep accurate payroll records to simplify the process of calculating unemployment taxes.

• Stay informed about changes in tax regulations to maintain compliance.

• Consider professional advice or reliable payroll software to manage FUTA obligations effectively.