Is FUTA Tax Deductible as a Business Expense?

The Federal Unemployment Tax Act (FUTA) tax is a federal tax that employers pay to help fund unemployment benefits for workers who lose their jobs. This tax is generally deductible for businesses.

Understanding FUTA Tax Deductibility

FUTA tax is considered an ordinary and necessary business expense under tax law, making it eligible for deduction. Since FUTA tax is an employer-paid tax, only employers are responsible for its payment and are therefore the only entities that can deduct it. Deducting FUTA tax reduces a business’s taxable income, which can lower its overall federal income tax liability. This tax differs from other payroll taxes, such as Social Security and Medicare taxes, because it is paid solely by the employer and is not withheld from employee wages.

Claiming the FUTA Tax Deduction

Employers claim the FUTA tax deduction on their federal income tax returns, with the specific form depending on their business structure. For sole proprietorships, FUTA tax expenses are reported on Schedule C (Form 1040), typically within the “Payroll Tax Expenses” or “Taxes and Licenses” categories. The net profit or loss from Schedule C then flows to the owner’s personal income tax return.

Partnerships report their FUTA tax expenses on Form 1065, U.S. Return of Partnership Income. These expenses are listed among other business deductions on the form, contributing to the calculation of the partnership’s ordinary business income or loss. S-corporations claim the deduction on Form 1120-S, U.S. Income Tax Return for an S Corporation, where FUTA tax is included as a payroll expense. C-corporations, which file Form 1120, U.S. Corporation Income Tax Return, also deduct FUTA tax as a business expense, often categorized under taxes or salaries and wages.

FUTA Tax Credits and Deductible Amount

The actual amount of FUTA tax paid, and thus the deductible amount, is significantly influenced by tax credits. 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 substantial credit, up to 5.4%, for timely payment of their State Unemployment Tax Act (SUTA) taxes. This credit effectively reduces the net FUTA tax rate to 0.6% for most employers. For instance, if an employer pays $7,000 in wages to an employee and qualifies for the maximum 5.4% credit, the FUTA tax due would be 0.6% of $7,000, or $42 per employee. This lower amount is what the employer ultimately deducts.

In some cases, states may be designated as “credit reduction states” if they have outstanding federal unemployment insurance loans. When a state is a credit reduction state, the FUTA credit available to employers in that state is reduced, which increases the effective FUTA tax rate and, consequently, the amount of FUTA tax owed and deductible. For example, a state might see its credit reduced by 0.3% for each year a loan remains unpaid, meaning employers in that state would pay a higher FUTA tax rate than the standard 0.6%. This adjustment directly impacts the total FUTA tax liability that a business can deduct.