How to Calculate and Report FUTA Tax

The Federal Unemployment Tax Act (FUTA) establishes an employer-paid tax to fund state workforce agencies. This tax is a component of the federal and state partnership for administering unemployment insurance and job service programs. The funds collected under FUTA cover the administrative costs of these programs and provide a financial reserve from which states can borrow if their own unemployment funds are depleted.

Components of the FUTA Tax Calculation

A business is liable for FUTA tax if it paid $1,500 or more in total wages to employees in any calendar quarter during the current or previous year. An alternative test for liability is having at least one employee for some part of a day in any 20 or more different weeks during the year or the preceding year.

The foundation of the FUTA calculation is the taxable wage base, which is the first $7,000 in wages paid to each employee during a calendar year. Any amount paid to an employee beyond this threshold is not subject to FUTA tax. For example, if an employee earns $50,000 annually, only the initial $7,000 is considered for the FUTA calculation.

Not all payments to employees are considered wages for FUTA purposes. Certain types of compensation are exempt and should be excluded when determining an employer’s total taxable wages. Common exempt payments include contributions to employee health plans, group-term life insurance, and retirement plans like 401(k)s.

The gross FUTA tax rate is 6.0%, but this is rarely the final rate due to a credit system linked to state unemployment tax (SUTA) programs. Employers who pay their SUTA taxes in full and on time can receive a credit of up to 5.4%. This credit effectively reduces the net FUTA tax rate to 0.6% for most employers.

In some situations, the full 5.4% credit is not available. This occurs when a state has borrowed from the federal government to pay unemployment benefits and has not repaid the loan on time, designating it as a “credit reduction state.” Each year, the Department of Labor and the IRS determine which states are subject to a credit reduction and the rate. Employers in these states will have their FUTA credit reduced, increasing their net FUTA tax payment.

Step-by-Step Guide to Calculating FUTA Tax

The first step in the calculation process is to determine the total gross wages paid to all employees during the calendar year. This figure includes remuneration such as salaries, bonuses, and commissions, before any deductions.

Next, an employer must identify the portion of each employee’s wages subject to FUTA tax by applying the $7,000 annual wage base limit. For each worker, only the first $7,000 of their earnings is counted. After determining the taxable amount for each employee, these figures are summed to arrive at the total taxable FUTA wages.

With the total taxable FUTA wages established, calculate the gross FUTA tax liability by multiplying that amount by the 6.0% rate. Then, determine the SUTA credit by multiplying the taxable wages by the 5.4% maximum credit rate, assuming all state unemployment taxes were paid on time.

An adjustment is necessary if the business operates in a credit reduction state. Employers must consult annual IRS guidance to find the specific credit reduction percentage. The adjustment is calculated by multiplying the total taxable FUTA wages by the state’s credit reduction rate.

The final step is to calculate the net FUTA tax owed using the formula: Gross FUTA Tax (6.0%) minus the SUTA Credit (5.4%) plus any Credit Reduction Adjustment. For a business with $21,000 in taxable FUTA wages in a non-credit reduction state, the net tax would be $126 ($21,000 x 0.6%). If that business were in a state with a 0.9% credit reduction, its net tax would be $315.

Reporting and Depositing FUTA Tax

Employers report their annual FUTA tax liability to the IRS using Form 940, the Employer’s Annual Federal Unemployment (FUTA) Tax Return. This form is filed once a year and is due by January 31 of the following year. If all FUTA tax deposits were made on time, the filing deadline is extended to February 10.

To complete Form 940, an employer will need the figures from their tax calculation. This includes total payments to employees, exempt payments, total taxable FUTA wages, and any credit reduction adjustments.

The rules for depositing FUTA tax are based on the liability accumulated during a quarter. If an employer’s FUTA tax liability exceeds $500 for any calendar quarter, a deposit must be made by the last day of the month following that quarter’s end. If the liability is $500 or less, the amount can be carried over to the next quarter. If the total liability for the year is under $500, the payment can be made with the annual Form 940 filing.

All federal tax deposits, including those for FUTA, must be made using an approved electronic method. The Electronic Federal Tax Payment System (EFTPS) is a common option. Employers must be enrolled to use the system, which allows for scheduling payments and maintaining a record of deposits.