What Is FUTA and SUTA Tax? A Breakdown for Employers
Understand the system of federal and state unemployment taxes (FUTA, SUTA) for employers, including their interaction and obligations.
FUTA and SUTA taxes are a component of employer payroll responsibilities in the United States. These taxes contribute to unemployment insurance programs, which provide temporary financial assistance to eligible individuals who have lost their jobs through no fault of their own. These employer-paid taxes are designed to help stabilize the economy by supporting workers during periods of unemployment.
Understanding Federal Unemployment Tax (FUTA)
The Federal Unemployment Tax Act (FUTA) establishes a federal tax on employers to help fund state unemployment insurance programs. This federal tax ensures a baseline of funding for unemployment benefits across all states. The standard FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee annually. This $7,000 threshold is known as the FUTA wage base.
FUTA is paid solely by employers and is not withheld from employee wages. Employers who pay their state unemployment taxes on time can reduce their FUTA tax liability through a federal credit. This credit mechanism encourages employers to comply with state unemployment tax requirements.
Understanding State Unemployment Tax (SUTA)
State Unemployment Tax Act (SUTA) refers to state-specific taxes that employers pay to fund unemployment benefits within their respective states. While FUTA provides a federal framework, SUTA rates and taxable wage bases vary from state to state.
SUTA uses an “experience rating” system. This system adjusts an employer’s SUTA tax rate based on their history of unemployment claims. Employers with fewer unemployment claims against their account receive lower SUTA tax rates, while those with a higher number of claims face higher rates.
New employers start with a standard rate until they establish an experience history, which takes a few years. SUTA is an employer-only tax, though a few states require employee contributions. Employers receive their specific SUTA rate directly from their state’s unemployment agency.
The FUTA Credit and State Interaction
The FUTA credit mechanism allows employers to reduce their federal unemployment tax liability when they pay their state unemployment taxes. The gross FUTA tax rate is 6.0% on the first $7,000 of wages, but employers can claim a credit of up to 5.4% for timely SUTA payments. This credit effectively reduces the net FUTA tax rate to 0.6%.
A “credit reduction state” status occurs when a state has borrowed funds from the federal unemployment account and has not repaid those loans by a specific deadline. Employers in credit reduction states face a reduced FUTA credit, meaning their net FUTA tax rate will be higher than the standard 0.6%. For each consecutive year a state has an outstanding loan, the FUTA credit reduction increases, often by 0.3% annually. This increased FUTA liability serves as an incentive for states to repay their federal unemployment loans.
Reporting and Paying FUTA and SUTA
Employers are responsible for reporting and paying FUTA tax annually using Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. Although filed annually, FUTA tax deposits may be required quarterly. If an employer’s cumulative FUTA tax liability exceeds $500 in a quarter, they must deposit the tax by the last day of the month following that quarter. If the liability is $500 or less, it carries over to the next quarter until the cumulative amount surpasses the $500 threshold.
Reporting and paying SUTA are state-specific processes. Each state provides its own forms, electronic portals, and payment schedules for unemployment taxes. Employers must adhere to their respective state’s requirements for SUTA reporting and payments. Timely payment of both FUTA and SUTA is important to avoid penalties and to ensure the employer qualifies for the maximum FUTA credit.