Is California a Credit Reduction State for 2023?

The Federal Unemployment Tax Act (FUTA) establishes a federal tax that provides compensation to workers who lose their jobs. Employers receive a credit against their FUTA tax liability for contributions to state unemployment funds. A “credit reduction state” has outstanding federal loans for its unemployment insurance program, affecting the FUTA credit available to employers. For 2023, California was designated as a credit reduction state.

The FUTA Credit Reduction Mechanism

A FUTA credit reduction occurs when a state’s unemployment insurance trust fund has borrowed money from the federal government to pay unemployment benefits and has not repaid those loans by a specific deadline. When this happens, the standard FUTA credit available to employers in that state is reduced, effectively increasing their federal unemployment tax burden.

The standard FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee annually, also known as the FUTA wage base. Employers receive a credit of 5.4% against this 6.0% rate for timely contributions made to certified state unemployment funds. This credit brings the effective FUTA tax rate down to 0.6% (6.0% – 5.4%).

In a credit reduction state, the 5.4% credit is reduced by a specific percentage, depending on how long the state has had outstanding loans. This reduction directly increases the employer’s effective FUTA tax rate beyond the 0.6%.

California’s Federal Unemployment Tax Status in 2023

California was identified as a FUTA credit reduction state for the 2023 tax year. The specific credit reduction rate applied to California for 2023 was 0.6%.

Consequently, employers in California received a reduced FUTA credit of 4.8% (5.4% – 0.6%) instead of the standard 5.4%. This adjustment raised their effective FUTA tax rate from 0.6% to 1.2% (6.0% – 4.8%). This situation arose because California had outstanding loans from the federal government to support its unemployment insurance program. Employers in California needed to account for this higher rate when calculating their federal unemployment tax obligations for 2023.

Determining Your Additional FUTA Tax

Employers in California needed to calculate their additional FUTA tax liability for 2023 by applying the credit reduction rate. This involved multiplying the credit reduction rate by the FUTA taxable wages paid to each employee, up to the annual wage base of $7,000 per employee. For 2023, with a 0.6% credit reduction rate, an employer would owe an additional $4.20 per employee ($7,000 wage base x 0.006).

For example, if an employer paid an employee $7,000 or more in FUTA taxable wages during 2023, the calculation for that employee’s additional FUTA tax was $7,000 multiplied by 0.006 (0.6%). This resulted in an additional $42.00 per employee that the employer owed in federal unemployment taxes for the year. If an employee earned less than $7,000, the actual FUTA taxable wages paid to that employee would be used in the calculation instead.

This additional FUTA tax is reported and paid when filing Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, for the 2023 tax year. Employers must ensure accurate record-keeping of FUTA taxable wages paid to employees throughout the year to correctly determine their total FUTA liability, including any credit reduction amounts. The IRS provides specific instructions and schedules, such as Schedule A (Form 940), to assist employers in reporting FUTA tax liabilities for credit reduction states.