Workest HR Glossary F Federal Unemployment Tax Act (FUTA)

Definition of Federal Unemployment Tax Act (FUTA)

Federal Unemployment Tax Act (FUTA)

The Federal Unemployment Tax Act (FUTA) is a tax paid by employers to help pay unemployment benefits to workers who lose their jobs.

What is the Federal Unemployment Tax Act?

The Federal Unemployment Tax Act (FUTA) tax helps pay unemployment benefits to workers who lose their jobs. FUTA taxes are paid only by employers — employees do not have any amounts withheld for FUTA taxes. This tax is in addition to any state unemployment insurance you may owe. You must pay the tax each year.

  • The FUTA tax rate is 6%, but most employers receive a credit of 5.4% for the state unemployment tax rate. This brings the net federal tax rate down to 0.06%.
  • The FUTA tax has a wage base of $7,000. This is the maximum portion of an employee’s income subject to the tax. Applying this rate to the first $7,000 of wages for each employee results in a tax of up to $42 per employee.
  • FUTA tax amounts are reported separately from FICA and income taxes on Form 940.
  • FUTA taxes are deposited at the end of each quarter, each time the cumulative amount is greater than or equal to $500.

Basic FUTA information

The FUTA tax rate has been 6% since 2011.

FUTA is not the same as the Federal Insurance Contribution Act (FICA). Employers and employees pay FICA as a separate tax. It pays for Social Security and Medicare benefits.

Most employers must pay the FUTA tax. You are responsible for FUTA taxes if you:

  • Have at least one employee who works at least 20 weeks out of the year or
  • Paid employees at least $1,500 in any quarter

You are exempt from the FUTA tax for self-employed workers such as gig workers or independent contractors.

Employers must report their annual FUTA tax liability to the IRS on Form 940 by January 31. For example, file your company’s Form 940 for the 2022 FUTA taxes by January 31, 2023. If you paid all of your federal unemployment taxes on time, the IRS allows you to file your Form 940 by February 10.

State credit reduction

You can claim a 90% credit against the federal tax that must be contributed to the state fund if the state where you do business has an unemployment law that satisfies specific requirements. As a result, most employers receive a credit of 5.4% for the state unemployment tax rate.

However, if your state borrows money from the federal government to cover its state unemployment benefits liabilities and does not pay the money back in time, it is a credit reduction state. In those instances, you cannot claim the credit, meaning you must pay more FUTA taxes to the federal government.

The U.S. Department of Labor designates which states are credit reduction states.

Why is FUTA important to small businesses?

FUTA is one of the payroll taxes that employers must pay. Failure to comply can lead to IRS penalties.

What is the history of the federal unemployment tax act?

FUTA was one of the measures enacted because of the Great Depression. During that time, unemployment rates reached as high as 25%. Therefore, it was believed that wage replacement was crucial. Federal government officials believed that a wage replacement program would:

  • Prevent the need for workers to go on welfare
  • Maintain workers’ purchasing power
  • Stabilize and stimulate the economy during recessions

The Federal Unemployment Tax Act was enacted in 1939 to establish a framework for state and federal unemployment insurance.

Other terms similar to FUTA that can assist you

  • Payroll tax. Payroll taxes are monies deducted from employees’ wages to satisfy federal, state, or local Social Security taxes, Medicare tax, and unemployment tax requirements.
  • Department of Labor (DOL). The Department of Labor is often referred to as the DOL. It is the government entity responsible for overseeing regulations related to employment.

Summary of the definition of the Federal Unemployment Tax Act

FUTA is an employer-paid payroll tax that provides unemployment benefits to workers. Paying the tax is mandatory. However, you can get a credit against the tax under certain circumstances.

Similar glossary definitions you must know

  • After-tax deductions. After-tax deductions are payroll deductions that, according to the IRS, are not eligible for tax exemption status.
  • Tax notice. A tax notice, or tax assessment, is a document regarding your company’s account status, new filing frequency, or rate assignments.

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