If you are an employer, then you had best get familiar with the Federal Unemployment Tax Act, abbreviated as ‘FUTA’. All employers have to contribute to this tax, to assist in the unemployment account of the Federal government. FUTA is not relevant to employees.
When an employee is fired from a company, these funds are used as a form of compensation at the Federal level. States can also apply to this Federal fund if they have a high rate of unemployment and cannot cope. They must then repay the Federal government or face penalties.
Table of Contents
- What is FUTA?
- FUTA & Form 940 Breakdown
- How is FUTA Calculated?
- Exemptions to FUTA Payments
- 2021 Developments and Complications.
- How and Where Do I Pay FUTA Taxes?
- When Do I Pay FUTA Taxes?
- Methods of FUTA Payment
- What Constitutes An Employee for FUTA Taxes?
- What Organizations Are Exempt from FUTA Calculations?
- The State Unemployment Act (‘SUTA’)
- Exploring FICA and SECA
- Best Ways to Minimize FUTA, SUTA, and FICA Obligations
- FUTA & General Taxes Comparison Table
- The Bottom Line
- FUTA FAQs
What is FUTA?
FUTA is often discussed in tandem with the State Unemployment State Act (‘SUTA’) and the Federal Insurance Contributions Act (‘FICA’), both of which are explained in detail below. FUTA payments are often coordinated with SUTA taxes when a worker loses his or her job. The main requirements for FUTA are that:
- You run a business in the United States.
- You paid more than $1,500 in wages during any quarter in the past year.
The reason that SUTA taxes are often mentioned alongside FUTA is that SUTA payments are deductible from FUTA. So if you pay into SUTA your liability can be reduced all the way down to 0.6% for FUTA payments, with a maximum 5.4% reduction. But if you don’t make SUTA payments on time, your FUTA obligations will increase.
FUTA and SUTA funds are designed to protect the unemployed. Payments to these funds are labeled as ‘contributions’. Note that there are different requirements to meet each tax. For more details on SUTA contributions, you will need to locate your state employment department for further details. Both FUTA and SUTA were created together in 1939, as a response to an unemployment epidemic reaching 25%.
FUTA & Form 940 Breakdown
Form 940 is a critical form for all business owners. It is a form designed specifically to record FUTA. All business owners with a payroll system and employees need to file one. Thankfully, filling out the form is quite simple, as long as you have a relatively basic business model.
Fill out your name, address, and employer identification number at the top of the page. If you pay a tax preparer to fill out Form 940, make sure the preparer shows your business name exactly as it appeared when you applied for your EIN. Make sure that your EIN matches your business name, or the IRS will not accept your submission (i.e the entity that made the payment will not be matched to the entity that owes taxes to the IRS). Next, tick the appropriate box for what kind of filing you are doing. Tick all that apply:
- Amended – Making an amendment to a previous filing
- Successor Employer – Taking over the business from a previous employer
- No payments – No payments to employees in the current tax year
- Final: Business Closed or Stopped Wages – The business is no longer in operation
After you have filled out this major information, you can then proceed following the instructions. Many lines will not apply, and you can leave them blank. The hardest part is calculating your total FUTA obligations minus adjustments, and we go into this in detail below.
How is FUTA Calculated?
The FUTA tax is based on the wages and salaries of your employees. The rate is 6% on the first $7,000 of income for every employee. However, the effective rate can run as low as 0.6% in many instances. This is because SUTA taxes can be offset against FUTA taxes, to a maximum of 5.4%.
Most businesses will be paying the full amount of SUTA taxes. This means that the effective FUTA tax will be only 0.6%. To avail of this rate, the SUTA payments must be made on time.
Businesses who are not required to pay SUTA (for whatever reasons) will also get the lowest FUTA tax.
Calculating FUTA tax obligations is more straightforward than you might think. Let’s say you have 3 employees, John, Mary, and Frank. During the last quarter, you paid $10,000 to Mary, $5,000 to John, and $1,000 to Frank. Your total obligation is $13,000 (Only the first $7,000 of each employee is considered, so the max per employee per quarter is $7,000.)
The total amount subject to FUTA tax in this quarter would be $13,000 ($7,000 + $5,000 + $1,000 = $13,000). At a minimal tax rate of 0.6%, the FUTA deposit would be $13,000 * 0.006, for a total of $78. As this is less than the minimum of $500, no funds would have to be deposited, unless the previous quarter had a weight greater than $422.
Exemptions to FUTA Payments
There are a number of payments made to employees that do not qualify for FUTA contributions. These payments will include:
- Life insurance benefits.
- Payment for dependent care.
- Fringe benefits – travel expenses, health plans, lodging, flight tickets, etc
- Contributions to retirement accounts such as 401(k).
Outside of these areas, all areas of employee wages (including bonuses and promotions) are subject to FUTA. A full list of FUTA exemptions can be found on the official IRS 940 FUTA tax return. Remember that even if your business closed or was sold last year, you still have to take care of FUTA and other tax obligations.
Regardless of business size, FUTA is a necessity. If you are a small, medium, large, or corporate entity, FUTA must be paid, along with SUTA, Social Security, Medicare, Sales Tax, and any other necessary items.
2021 Developments and Complications.
While submission for a standard Form 940 is straightforward, there are certain instances that can be more involved. These include.
- Moving And Bicycle Expenses Subject To Futa Tax – The Tax Cuts and Jobs Act suspends the exclusion for qualified moving expense reimbursements from your employee’s income under section 132 and the deduction from the employee’s income under section 217, as well as the exclusion for qualified bicycle commuting reimbursements from your employee’s income under section 132, beginning after 2017 and before 2026. Therefore, moving expenses and bicycle commuting reimbursements aren’t exempt from FUTA tax during this period. Don’t include moving expenses or bicycle commuting reimbursements on Form 940.
- Certification Program For Professional Employer Organizations (PEOs) – The Stephen Beck ‘Achieving a Better Life Experience Act’ required the IRS to establish a voluntary certification program for PEOs. PEOs handle various payroll administration and tax reporting responsibilities for their business clients and are typically paid a fee based on payroll costs. To become and remain certified under the certification program, certified professional employer organizations (CPEOs) must meet various requirements described in sections 3511 and 7705, and related published guidance. Certification as a CPEO may affect the employment tax liabilities of both the CPEO and its customers. To become a CPEO, the organization must apply through the IRS Online Registration System.
- Outsourcing Payroll Duties – Generally, as an employer, you’re responsible to ensure that tax returns are filed and deposits and payments are made, even if you contract with a third party to perform these acts. You remain responsible if the third party fails to perform any required action. Before you choose to outsource any of your payrolls and related tax duties (that is, withholding, reporting, and paying over social security, Medicare, FUTA, and income taxes) to a third-party payer, such as a payroll service provider or reporting agent, check with the IRS guidelines first.
As with anything tax-related, there are potential areas of complication. If you changed your business name or address, then notify the IRS of the name change immediately. Otherwise, it will lead to an error, and the IRS is not known for their forgiveness. It is your responsibility to report any changes to them.
It’s worth noting that Form 940 is distinct from Form 941. Form 941 is the quarterly Federal tax return. This is filed every quarter. The two forms might seem similar in both their name and appearance but relate to separate areas. Form 941 relates to FICA and states the employer tax withholdings (More differences on FICA vs FUTA are explained below).
Payroll records need to be reconciled with Form 941, and you’ll need to take into account Federal Income Tax Withholding, the total compensation to employees, and employee and employer contributions to Social Security and Medicare wages. All things considered, Form 940 is easy to fill out in comparison to other forms, and only needs to be sent on an annual basis.
How and Where Do I Pay FUTA Taxes?
The IRS encourages people to file their FUTA taxes (and, indeed, all taxes) electronically. And it’s a lot easier to file electronically than by mail. For more information on electronic filing, see this site. A table of mailing addresses for paper filing is outlined below, for those who do wish to opt for the traditional filing route.
|Location of Business Residence||FUTA Form Without Payment||FUTA Form With Payment|
|Connecticut, Delaware, District of Columbia, Georgia, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, West Virginia, Wisconsin||Department of the Treasury Internal Revenue Service Kansas City, MO 64999-0006||Internal Revenue Service P.O. Box 806531 Cincinnati, OH 45280-6531|
|Alabama, Alaska, Arizona, Arkansas, California, Colorado, Florida, Hawaii, Idaho, Iowa, Kansas, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Texas, Utah, Washington, Wyoming||Department of the Treasury Internal Revenue Service Ogden, UT 84201-0046||Internal Revenue Service P.O. Box 932000 Louisville, KY 40293-2000|
|Puerto Rico, U.S. Virgin Islands||Internal Revenue Service P.O. Box 409101 Ogden, UT 84409||Internal Revenue Service P.O. Box 932000 Louisville, KY 40293-2000|
|Location Unlisted||Internal Revenue Service P.O. Box 409101 Ogden, UT 84409||Internal Revenue Service P.O. Box 932000 Louisville, KY 40293-2000|
|EXCEPTIONs – > for tax-exempt organizations, federal, state, and local governments, and Indian tribal governments, regardless of your location||Department of the Treasury Internal Revenue Service Ogden, UT 84201-0046||Internal Revenue Service P.O. Box 932000 Louisville, KY 40293-2000|
When Do I Pay FUTA Taxes?
To pay FUTA taxes, you will need to familiarize yourself with the IRS Form 940, mentioned above. This is one of the most common tax forms, along with Form 1040 and Schedule SE.
IRS Form 940 contains all of the relevant details with regard to FUTA. If your FUTA tax obligations were more than $500 in any given quarter, then you must file the relevant paperwork on the last day of the month after that quarter.
If your FUTA obligations are less than $500 in any given quarter, then you file in the next quarter when the obligation is above $500. The table below lists the FUTA dates.
|Undeposited FUTA tax more than $500 on:||Deposit Tax by:|
|March 31||April 30|
|June 30||July 31|
|September 30||October 31|
|December 31||January 31|
Methods of FUTA Payment
You can only pay FUTA taxes using Electronic Funds Transfer (‘EFT’). In fact, this is true for all Federal Tax Deposits. And it is quite easy to do, with an online portal known as the Electronic Federal Tax Payment System (‘EFTPS’). This service is provided free of charge by the US Department of Treasury. It is easy to enroll and validate credentials, after which you can pay the IRS your dues. You must be enrolled to use this service. If the website goes down for any reason, you still need to pay your taxes on time!
Of course, you can make an electronic transfer without going through the EFTPS system, if you wish. You would do so with an ACH or same-day wire transfer. Your accountant could also potentially pay on your behalf, but these options cost money. The EFTPS system is the most straightforward.
If you fail to submit a deposit transaction on EFTPS by 8 p.m. Eastern time the day before the date a deposit is due, you can still make your deposit on time by using the Federal Tax Collection Service (‘FTCS’) to make a same-day wire payment. To use the same-day wire payment method, you will need to make arrangements with your financial institution ahead of time. Please check with your financial institution regarding availability, deadlines, and costs.
While FUTA obligations are annual in terms of filing, the tax needs to be deposited quarterly if it is more than $500. If FUTA tax liability is $500 or less in a quarter, carry it forward to the next quarter and continue to do so until your cumulative FUTA tax liability is more than $500. At that point, you must deposit your FUTA tax for the quarter.
What Constitutes An Employee for FUTA Taxes?
All full-time and part-time employees are to be included in FUTA calculations. But this only applies to employees and not other workers types. This is a huge relief to businesses that make extensive use of freelancers/independent contractors, as well as consultants. For businesses that are run as a partnership, the partner does not qualify as an employee under FUTA.
If you employ a household worker (somebody who performs work in a home or college club/fraternity) then you can either file the typical IRS Form 940 or the standard Schedule H. Household employers that paid more than $1,000 in any given quarter to an employee will be liable under FUTA.
What Organizations Are Exempt from FUTA Calculations?
A number of businesses are exempt from FUTA payments, as listed on the IRS Form 940. All organizations set up under section 501 (c) of the IRS tax code are exempt. This includes religious, scientific, educational, charitable, and other non-profit institutions.
Many Indian tribal governments are also exempt from filing FUTA IRS Form 940s (i.e. from paying FUTA taxes). However, there are certain conditions that need to be met. The Indian tribal government must have participated in the state unemployment system for the preceding year and be in compliance with the provisions under section 3309(d).
While some organizations are exempt completely, others will have special requirements due to their unique circumstances. For businesses in the agricultural industry, the wages of $20,000 per quarter are the minimum threshold for the purpose of FUTA. 10 or more employees will need to have been working at the same time.
The State Unemployment Act (‘SUTA’)
Every state has an unemployment fund, mandated by the State Unemployment Act. While FUTA is easy to understand with a single 6% rate paid quarterly, SUTA can get complex. This is because each state will have special requirements. The rate may change each year, and so can the total taxable minimum income. In addition, certain industries could have different rates, depending on how well they are doing.
This means that a business could be required to pay more than the 0.6% as stipulated under FUTA. But they will never pay less than it unless they are exempt for some particular reason. Another item to keep in mind is that states use different names for their SUTA obligations. Some states call it a re-employment tax, others refer to it as State Unemployment Insurance (‘SUI’), and more label it the Department of Unemployment Assistance (‘DUA’) payment.
Exploring FICA and SECA
FICA is the most common social welfare tax. It consists of taxes to pay for Social Security programs (housing projects, veterans, disability, retirement, etc) and Medicare. There is no way to avoid paying these contributions.
The higher the wage of the employee, the higher FICA will be. FICA rates are set annually, though they can remain the same (the current 2020 rate is the same as for 2019). FICA is paid by both employers and employees.
Self-employed business owners pay a Self Employment Tax (‘SECA’) consisting of Social Security and Medicare. To simplify, employees pay FICA while employers pay SECA, which is the same thing (Medicare and Social Security). However, employers pay half of the employee FICA, which can make things complex.
Social security contributions do have a max limit, after which no further contributions need to be paid. Presently, the max limit for social security contributions is $137,700. There is no max for Medicare contributions, however.
As a simple example of a self-employment tax contribution. A business owner that earned $250,000 would pay 6.2% for social security (on $137,700) and 1.45% for Medicare (on $250,000). The total would be $8,537 for social security and $3,625 for Medicare, summing up to $12,162. The employer would then have to pay FUTA and SUTA separately and match the Medicare contributions made by employees.
Best Ways to Minimize FUTA, SUTA, and FICA Obligations
The best way to reduce all of these obligations is to make use of independent contractors as much as possible. It is Federally mandated that employers pay for FUTA, SUTA, and FICA taxes. These taxes really add up – especially when taking into account all the other considerations like hiring and interviews, insurance, training, recruitment, etc.
Other than this, there is no real way to reduce these obligations. The best thing to do is to get a good accountant who can give you advice and fill in the relevant documentation on time. The sloppier you are with filing tax returns, the bigger they will get. As a rule of thumb, it’s better to file quarterly so you can manage cash flow. It’s never nice to have to pay a large sum of money to the tax office near the end of the year.
Self-employed individuals will need to file a Schedule C (also known as IRS Form 1040 ) each quarter. In addition to this, self-employed persons must file a Form SE. Schedule C is useful in determining your tax obligations. Penalties and interest will accrue on all tax payments that are late.
FUTA & General Taxes Comparison Table
The major taxes that employers have to pay include FUTA, SUTA, Sales Tax, Medicare, and Social Security. All of these taxes are outlined in the table below. These are the official rates, but be mindful that there are always going to be subcategories, deductions, and other factors that can increase or decrease your liability.
|Sales Tax (’VAT’)||10%||Applied at the final point of sale (retailer, wholesalers, etc excluded)|
|SUTA||Varies by State. Generally 2%-5%||Employers only.|
|FUTA||6%. Can be reduced to 0.6%||Employers only|
|Medicare||1.45% (matched by employer)||Employers and Employees. The rate can go to 2.4% for employees earning above $200,000.|
|Social Security||6.2%||Employers and Employees|
FUTA is a necessary tax that does not amount to much for small business owners. But it still helps to understand this tax and its relationship to SUTA and FICA. FUTA and SUTA obligations alone will total 6%, which is a hefty quarterly tax on the first $7,000 of employee wages. It can also hit small businesses disproportionately to large enterprises.
What is the FUTA tax in brief?
The FUTA tax is a mandatory obligation on business owners with employees, who paid more than $1,500 in wages in a given quarter. These taxes go to a Federal fund to assist the unemployed.
What is the FUTA tax rate?
The FUTA tax rate is 6% as a default on the first $7,000 earned by an employee. However, there are significant tax deductions available down to 0.6%.
How do I avoid paying this tax?
There are no ways to avoid paying this tax unless you do not have any employees or you are an exempt entity as described under the IRS Form 940 guidelines. You can greatly reduce FUTA by paying your SUTA obligations on time or by using independent contractors.
What payments are exempt from FUTA tax?
Life insurance, retirement contributions, fringe benefits, and dependent care payments are exempt from FUTA calculations.
When is FUTA tax due?
The FUTA tax deposit is due on the last day of each quarter (March, June, September, December) where the total obligations exceed $500. Whenever the FUTA obligation exceeds $500, a FUTA deposit is due on the last day of that quarter.
What is additional Medicare withholding?
Employees that earn more than $200,000 are subject to an additional 0.9% tax on top of the 1.45%. This additional tax is withheld by the employer for payment.