What Is FUTA? Federal Unemployment Tax Explained

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FUTA, short for the Federal Unemployment Tax Act, is the federal law that imposes a payroll tax on employers to pay for the unemployment insurance system in the United States. The tax is 6% of the first $7,000 in wages paid to each employee per calendar year. Most employers do not pay the full 6%: a credit of up to 5.4% for state unemployment taxes paid on time brings the usual net rate down to 0.6%. That works out to at most $42 per employee per year. Employers pay all of it. Nothing is withheld from a worker’s paycheck.

What FUTA Means

The Federal Unemployment Tax Act is part of the Internal Revenue Code. It works together with the federal-state unemployment insurance system created by the Social Security Act of 1935. Under that system, each state runs its own unemployment insurance program and sets its own benefit rules. Each state also collects its own employer tax, usually called SUTA (State Unemployment Tax Act) or state unemployment insurance (SUI) contributions. The federal tax sits on top of the state tax. Its revenue pays to administer these programs in every state, funds the federal share of extended benefits during periods of high unemployment, and supports a loan fund that states can borrow from when their own trust funds run short.

FUTA is an employer cost calculated on employee wages. It differs from income tax withholding and from Social Security and Medicare taxes because no part of it comes out of the employee’s pay. A worker’s pay stub will not show a FUTA line; if FUTA appears there as a deduction, the deduction is incorrect. A worker cannot claim FUTA as their own tax payment.

How FUTA Works

The rate and the wage base

The statutory rate is 6.0%. It applies only to FUTA taxable wages, and only up to $7,000 per employee per calendar year. Once an employee’s wages pass $7,000 in a year, the employer owes no further FUTA on that person until the next January 1, when the count starts over.

The $7,000 wage base has not changed since 1983. The rate was 6.2% for many years because of a temporary surtax, which expired in mid-2011. Since then the gross rate has been 6.0%.

Because of the cap, FUTA is a fixed cost per worker once wages pass the base. An employee earning $40,000 and one earning $280,000 produce the same FUTA bill: 6% of $7,000, which is $420 gross or $42 at the 0.6% net rate. FUTA paid by an employer also has no bearing on how much unemployment compensation a worker receives. Benefit amounts are set by state law, typically from the worker’s earnings history during a base period and subject to a state weekly maximum.

The state unemployment tax credit

The federal and state taxes are designed to work together. Employers can credit their state unemployment contributions against the federal tax, up to 5.4% of FUTA taxable wages. An employer that takes the full credit pays:

Net FUTA rate = 6.0% − 5.4% = 0.6%

To get the maximum credit, an employer must:

• Pay state unemployment tax on the same wages that are subject to FUTA, in full and by the state due date.
• Not pay wages in a credit reduction state (explained below).

The credit is not capped at the employer’s actual state rate. If a state assigns an employer a low experience rate (for example 2% because few former employees have claimed benefits), the employer can still receive the full 5.4% federal credit. The difference is treated as an additional credit for having a favorable state rate.

Paying the state late shrinks the credit. Under the Form 940 instructions, state contributions paid after the Form 940 due date earn only 90% of the credit they would otherwise have earned. Wages that are exempt from state unemployment tax but still subject to FUTA earn no credit at all. On those wages, the employer owes the full 6%.

Credit reduction states

A state can borrow from the federal government when its unemployment trust fund cannot cover benefit payments. If the loan stays unpaid long enough, employers in that state lose part of their FUTA credit. The reduction increases each year the balance remains outstanding. The extra cost lands on employers and is calculated on Schedule A of Form 940. The IRS and the Department of Labor publish the list of credit reduction states after each year ends. A state’s status is not fixed, so the list for one year does not carry over to the next.

How to Calculate FUTA Tax

The calculation has four steps:

1. For each employee, total the wages paid during the calendar year.
2. Subtract payments that are exempt from FUTA (see the exemptions section).
3. Cap each employee’s remaining wages at $7,000. The total across all employees is the FUTA taxable wage base.
4. Multiply by 6%, then subtract the allowable state credit. With the maximum credit, this is the same as multiplying taxable wages by 0.6%.

FUTA liability = FUTA taxable wages × (6.0% − credit rate)

Worked example (hypothetical)

A small company has two employees. Assume all of their pay is FUTA taxable, the company pays its state unemployment tax on time, and it is not in a credit reduction state.

First quarter:

• Gross FUTA: $12,000 × 6.0% = $720
• State credit: $12,000 × 5.4% = $648
• Net FUTA for Q1: $72 ($12,000 × 0.6%)

Second quarter: Employee A earns another $10,000. None of it is FUTA taxable because A already reached $7,000 for the year. Employee B earns another $5,000. Only $2,000 of it is taxable, because B had $5,000 of taxable wages in Q1. Q2 taxable wages are $2,000, and net FUTA is $12.

For the rest of the year, neither employee generates any FUTA. The annual net total is $84 on $14,000 of taxable wages, the maximum for two employees ($42 each).

Two features of the example are typical of how FUTA behaves. First, the tax is front-loaded: higher-paid workers reach the $7,000 base early in the year, so most of the liability is recorded in the first quarter or two. Second, the net amounts are small, which matters for the deposit rules covered below.

Who Must Pay FUTA

Employers pay FUTA. Whether a particular employer is liable depends on which category it falls into, with the tests below applied to the current and previous calendar years.

Businesses (general test)

A business is liable for FUTA if it meets either condition:

1. It paid wages of $1,500 or more to employees in any calendar quarter of the current or previous year.
2. It had at least one employee (full-time, part-time or temporary) for some part of a day in 20 or more different weeks during the current or previous year. The weeks do not need to be consecutive.

Because both tests look back to the previous year, a business that crossed either threshold last year is liable this year even if its payroll has shrunk.

Only employees count. Payments to independent contractors are not wages for FUTA purposes. Worker classification therefore directly affects both the liability tests and the tax base.

Household employers

People who hire household workers, such as a nanny, babysitter, housekeeper or caretaker, face a different test. The same rule covers workers in a private home, a local college club, or a local chapter of a college fraternity or sorority. The employer owes FUTA if it paid cash wages of $1,000 or more to household employees in any calendar quarter of the current or previous year.

Household employers usually report FUTA on Schedule H, filed with their Form 1040, rather than on Form 940. Wages paid to the employer’s spouse, to the employer’s child under age 21, or to the employer’s parent are generally excluded from household FUTA.

Agricultural employers

Farm employers are liable if either condition is met:

1. They paid cash wages of $20,000 or more to farmworkers in any calendar quarter of the current or previous year.
2. They employed 10 or more farmworkers for some part of a day in 20 or more different weeks during the current or previous year.

An employer with both farm and non-farm workers applies each test to the relevant group of workers.

Exempt Employers and Payments

Some organizations owe no FUTA:

• Section 501(c)(3) organizations. Religious, charitable, educational and scientific organizations exempt under section 501(c)(3) do not pay FUTA. Organizations exempt under other parts of section 501(c) are not automatically exempt.
• State and local governments. Services performed for a state or local government are exempt from FUTA.
• Indian tribal governments. These are exempt and do not file Form 940, provided the tribe participated in the state unemployment system for the full year and complies with applicable state unemployment law.

Exemption from FUTA does not always mean exemption from unemployment coverage. Nonprofits and governments may still have state unemployment obligations, sometimes with the option to reimburse the state for benefits paid rather than pay contributions.

Some payments also fall outside FUTA taxable wages even when the employer is liable. Common examples:

• Wages paid to the employer’s spouse, a child under 21, or a parent, under family employment rules.
• Many fringe benefits, including certain health and accident plan payments.
• Group-term life insurance.
• Employer contributions to qualified retirement plans.

These amounts are reported on Form 940 as exempt payments and subtracted before the $7,000 cap is applied. FUTA’s definition of wages is close to, but not identical with, the treatment of the same items for income tax withholding or FICA.

Depositing and Reporting FUTA

FUTA has two separate obligations: depositing the tax during the year and filing an annual return.

Deposits

The deposit schedule is based on the amount owed, not the filing date. At the end of each quarter, an employer totals the net FUTA owed but not yet deposited:

• If the cumulative undeposited amount is more than $500, it must be deposited by the last day of the month after the quarter ends.
• If it is $500 or less, it carries forward and is added to the next quarter’s amount.
• Any balance still undeposited after the fourth quarter is either deposited by January 31 or, if $500 or less, paid with Form 940.

In the worked example, the company’s Q1 liability was $72, well under $500, so it rolls forward. At the 0.6% net rate, an employer reaches the $500 threshold at about $83,334 of taxable wages, which means roughly 12 employees at the full wage base. Smaller employers paying the net rate often end up making one payment with the annual return. Larger employers, and those paying a higher rate because of a reduced credit, will usually have quarterly deposits.

Federal tax deposits must be made by electronic funds transfer, typically through the Electronic Federal Tax Payment System (EFTPS). If a due date falls on a Saturday, Sunday or legal holiday, the deadline moves to the next business day.

Filing Form 940

Liable employers file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, with the IRS each year. The return reports total payments to employees, exempt payments, wages above the $7,000 base, the credit claimed and any credit reduction (on Schedule A). It also reconciles deposits against the year’s total liability.

• Due date: January 31 for the previous calendar year. Employers that deposited all FUTA on time get until about February 10.
• Method: Form 940 can be filed electronically or on paper. A paper return counts as on time if it is properly addressed and postmarked by the due date.
• Who signs: a sole proprietor, a principal officer of a corporation, an authorized partner or member, or a fiduciary.
• Amendments: errors are corrected on a new Form 940 with the “amended return” box (box a) checked. The IRS prefers electronic amendments.
• Final return: an employer filing its last Form 940 because it closed or stopped paying wages checks box d to tell the IRS no further returns will follow.

FUTA vs. SUTA

FUTA and SUTA are two layers of the same system. Both are employer taxes on wages up to a capped base, and both fund unemployment insurance. They differ in who sets the terms:

New employers usually start at a standard new-employer state rate. That rate later moves up or down depending on how many former employees collect benefits charged to the employer’s account. A few states also require employees to contribute to the state program through withholding. FUTA itself never does.

FUTA vs. FICA

FICA (Federal Insurance Contributions Act) is the other major federal payroll tax. It is often confused with FUTA because both are calculated on wages. They differ on every point that matters for payroll:

• Who pays: FICA is split between employer and employee. Each pays 6.2% for Social Security, up to that year’s Social Security wage base, plus 1.45% for Medicare with no cap. The employee share is withheld from pay, and an additional Medicare tax applies to high earners. FUTA is employer-only.
• What it funds: FICA funds Social Security and Medicare. FUTA funds unemployment insurance.
• Wage base: FICA’s Social Security base is adjusted annually and is many times larger than FUTA’s fixed $7,000.
• Self-employment: self-employed people pay the equivalent of both FICA halves through self-employment tax. They owe no FUTA on their own earnings.
• Reporting: FICA is reported with income tax withholding, usually on quarterly Form 941. FUTA has its own annual Form 940.

Limitations and Common Misunderstandings

FUTA is not the main cost of unemployment insurance. At $42 per employee per year at the net rate, the federal tax is usually much smaller than the state tax. Budgeting for unemployment insurance costs mostly means understanding the state rate and wage base.

The wage base resets for each employer. Every employer tracks its own employees’ $7,000 base separately. An employee who changes jobs mid-year starts a new $7,000 base with the new employer. In some cases, such as a successor employer that acquires a business, wages paid by the previous owner can count toward the base.

The Bottom Line

FUTA matters to any employer that meets the wage or employee tests, including household and farm employers under their own thresholds. Paying state unemployment tax on time keeps the federal rate near 0.6%, and small employers often settle the whole year with Form 940. For budgeting, the state unemployment rate and wage base usually drive the larger cost.