How to Calculate FUTA Tax With Rates and State Credits

The Federal Unemployment Tax Act (FUTA) is a federal tax on employers that helps fund unemployment compensation programs. This tax provides a financial safety net for workers who lose their jobs through no fault of their own, contributing to both federal and state unemployment benefit systems. Understanding FUTA is an important part of managing payroll liabilities for businesses.

Understanding FUTA Basics

FUTA is an employer-only tax, meaning it is paid by businesses, not employees. Funds collected go into the Unemployment Trust Fund, supporting unemployment compensation initiatives, including federal extended benefits and state agency administrative costs.

Key Elements for FUTA Calculation

FUTA tax calculation involves understanding specific components, starting with the FUTA wage base. For 2024, FUTA applies only to the first $7,000 of wages paid to each employee. FUTA wages include salaries, commissions, bonuses, and vacation pay.

The gross FUTA tax rate is 6.0% on these taxable wages. Most employers pay less due to a credit.

State Unemployment Tax Credit

Employers can receive a credit against their FUTA tax liability by timely payments to state unemployment tax (SUTA) programs. This credit impacts the FUTA tax burden for most businesses. Its purpose is to encourage employers to contribute to their state’s unemployment insurance fund.

The maximum allowable credit is 5.4%, which reduces the gross FUTA tax rate. When eligible for the full credit, an employer’s net FUTA tax rate becomes 0.6% (6.0% gross rate minus the 5.4% credit). This reduction emphasizes compliance with state unemployment tax obligations.

However, the full 5.4% credit may not always be available, particularly in “credit reduction states.” A state becomes a credit reduction state if it has outstanding federal unemployment loans. Employers in these states will experience an increase in their effective FUTA tax rate because their available credit is reduced.

For 2024, California, New York, and the U.S. Virgin Islands are designated as credit reduction states. For instance, employers in California and New York face a 0.9% credit reduction, resulting in an effective FUTA rate of 1.5% (6.0% – 4.5% credit). The U.S. Virgin Islands has a 4.2% credit reduction, leading to a FUTA rate of 4.8%. These reductions mean employers pay more FUTA tax per employee, as the credit is typically lowered by 0.3% for each year the loan remains unpaid.

How to Calculate Your FUTA Tax

To calculate your FUTA tax, first identify the total FUTA taxable wages paid to all employees, capped at the first $7,000 of wages for each employee. Next, determine the applicable net FUTA tax rate for your business, considering any potential credit reductions. This rate will be 0.6% if you are not in a credit reduction state and have paid your state unemployment taxes on time.

To illustrate, consider an employer with two employees, each earning $10,000 or more in a year. If the employer is in a state not subject to a credit reduction, the calculation would be $7,000 (wage base) multiplied by 0.6% (net FUTA rate), resulting in $42 per employee. For two employees, the total FUTA tax would be $84 ($42 x 2).

Now, imagine the same employer is located in California, a credit reduction state for 2024 with a 0.9% reduction. The effective FUTA rate for this employer would be 1.5% (6.0% gross rate – 4.5% adjusted credit). The calculation would then be $7,000 (wage base) multiplied by 1.5% (adjusted net FUTA rate), yielding $105 per employee. For two employees, the total FUTA tax would be $210 ($105 x 2).

Reporting and Paying FUTA

After calculating the FUTA tax liability, employers must report and pay these amounts to the Internal Revenue Service (IRS). The primary form used is Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. This form is filed annually and summarizes the FUTA tax owed for the entire calendar year.

FUTA tax deposits are required quarterly if the liability exceeds a certain threshold. If the FUTA tax liability for a quarter is more than $500, employers must deposit the tax by the last day of the month following the end of the quarter. If the liability is $500 or less, it can be carried forward to the next quarter until the cumulative amount exceeds $500. All federal tax deposits, including FUTA, must be made through electronic funds transfer (EFT). The annual Form 940 is due by January 31 of the following year, though an extension to February 10 is granted if all FUTA taxes were deposited on time.