Do S Corp Owners Have to Pay Unemployment Tax?

Unemployment taxes fund programs providing temporary financial assistance to individuals who lose their jobs. Understanding these obligations is important for managing business finances and ensuring compliance, as this system impacts payroll and tax responsibilities.

The Basics of Unemployment Tax

Unemployment tax consists of two components: the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA) taxes. Both are employer-paid taxes, funding unemployment compensation programs that offer financial support to eligible workers.

FUTA tax contributes to a federal trust fund that helps states administer unemployment programs. For most employers, FUTA applies if they paid wages of at least $1,500 in any calendar quarter or employed at least one worker for 20 or more weeks during the current or prior year. This federal tax is levied on the first $7,000 of wages paid to each employee annually.

SUTA, also known as State Unemployment Insurance (SUI), is managed at the state level. Rules, tax rates, and wage bases vary by state. These state-level taxes directly fund unemployment benefits paid to individuals within that state. Most states require employers to pay SUTA, though some may require employee contributions.

S Corporation Owners and Taxable Wages

S Corporations are distinct in how they handle owner compensation and unemployment taxes. An S Corporation, as an employer, must pay unemployment taxes on the wages it pays to its employees. This requirement extends to the S Corporation owner if they work for the company and receive a salary.

The Internal Revenue Service (IRS) requires S Corporation owners who provide services to the company to pay themselves a reasonable salary. This salary is subject to employment taxes, which include FUTA and SUTA, similar to wages paid to any other employee. This must occur before taking any non-wage distributions, such as pass-through income.

Distributions, or the pass-through income from an S Corporation, are generally not subject to employment taxes, including unemployment taxes. This is why the IRS emphasizes the reasonable compensation rule; it prevents S Corporation owners from avoiding employment taxes by classifying all their income as distributions rather than wages for services rendered. Factors considered when determining reasonable compensation include the owner’s training, experience, duties, responsibilities, the time and effort devoted to the business, and what comparable businesses pay for similar services. Failing to pay a reasonable salary can lead to IRS reclassification of distributions as wages, resulting in back taxes, interest, and penalties.

Determining and Reporting Unemployment Tax

Calculating FUTA tax involves applying the federal tax rate to the taxable wage base for each employee. The standard FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee annually. However, employers typically receive a credit of up to 5.4% against this rate if they pay their state unemployment taxes on time, effectively reducing the net FUTA rate to 0.6%. In some instances, if a state has outstanding federal loans for its unemployment fund, employers in that state may experience a credit reduction, which can increase their effective FUTA rate.

SUTA tax calculation varies by state, with each state setting its own wage base and tax rate. These state-specific rates often depend on an employer’s “experience rating,” which reflects the history of unemployment claims made by their former employees. Businesses with a lower history of unemployment claims generally have a lower SUTA tax rate, while those with higher turnover or more claims may face higher rates. Many states provide employers with an annual SUTA rate notice detailing how their specific rate was determined.

For federal unemployment tax, employers must file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, annually. This form is due by January 31st of the year following the calendar year being reported. While Form 940 is an annual filing, FUTA tax deposits may be required quarterly if the accumulated liability exceeds $500. State unemployment taxes are typically reported and paid on a quarterly basis using state-specific forms, which are often accessible through state workforce agency websites.