How to Calculate the Federal Unemployment Tax (FUTA)
While it’s every small business owner’s nightmare to let go of any employees, sometimes layoffs are the only way to keep the business afloat.
Unemployment benefits can keep employees who’ve lost their jobs on their feet while they seek new work. Since 1939, the Federal Unemployment Tax Act (FUTA) has funded a cushion for workers who lose their jobs through no fault of their own.
Overview: What is the federal unemployment tax act ?
The Federal Unemployment Tax Act came into law after the worst recession the U.S. had ever seen, where unemployment spiked to unprecedented levels. FUTA funded a program that compensates those who lose their jobs due to layoffs, and sometimes firings.
FUTA joined the Social Security Act of 1935 to create a suite of economic security programs that buoy individuals and the U.S. economy during hard times. The Social Security Act of 1935 had administered unemployment benefits until FUTA was enacted in 1939.
Since then, the government has added several national programs, including Medicare and Medicaid, and business taxes partially fund many of them.
If you’ve ever applied for unemployment benefits, you know it’s managed at the state and territory level. Though the federal government collects tax for unemployment, the money gets distributed to each state and participating territory, which is then disbursed to residents in need.
Employers fund federal unemployment through a FUTA payroll tax. The amount owed, or liability, depends on the number of employees and their wages. Businesses don’t pay FUTA tax on contractors since they’re not considered employees.
FUTA is an employer tax, so employees do not pay into it.
As an employer, you also pay state unemployment tax (SUTA), and in Alaska, New Jersey, and Pennsylvania, employees chip in, too. Often, when your business pays state unemployment tax, your FUTA tax rate is reduced. Together, FUTA and SUTA compensate people who’ve lost their jobs.
How to calculate FUTA tax
Before we calculate FUTA tax, let’s identify the organizations and people whose wages are subject to it.
Your small business owes FUTA tax if:
- You’ve paid employees $1,500 or more in any quarter of the year
- You’ve had one or more employees working at least 20 weeks during the year, even if they’re part-time or temporary employees and worked part of a day
The exceptions to FUTA tax are:
- 501(c)3 organizations
- The wages of your children under 21 if you’re their employer
Today, employers must pay federal unemployment tax on 6% of each employee’s eligible wages, up to $7,000 per employee.
Usually, your business receives a tax credit of up to 5.4% from the federal government when it pays its state unemployment tax, effectively reducing the FUTA rate to 0.6%. Check with your state unemployment tax rules to make sure your business qualifies for the credit.
The 5.4% tax credit is reduced if the business’s state or territory fails to repay the federal government for money borrowed to pay unemployment benefits. In 2019, the Virgin Islands received the only reduction of this kind.
If you classify as an employee to your S-Corporation, your business must pay FUTA tax on your wages. Most other business types do not subject owners’ pay to FUTA tax, making owners ineligible to receive unemployment benefits.
Since the tax is limited to the first $7,000 of employee wages, these taxes usually go away in the first few months of the year for full-time employees.
To calculate your business’s FUTA tax liability, determine your employees’ wages subject to FUTA tax. Start with their gross pay -- their total salary or wages before deductions and taxes -- and subtract:
- Fringe benefits, though there are exceptions like moving costs
- Group term life insurance payments
- Retirement or pension contributions
- Dependent care payments
Let’s say you have three employees -- two part-time and one full-time -- with the following earnings for the year:
|Employee No.||Gross pay||Eligible fringe benefits||Group term life insurance||Dependent care payments||FUTA wages|
The FUTA tax liability is based on $17,600 of employee earnings ($4,900 + $5,700 + $7,000). Employee 3 has $37,100 in eligible FUTA wages, but FUTA applies only to the first $7,000 of each employee’s income.
Your small business’s FUTA tax liability for the year is $105.60 ($17,600 * 0.006).
When are FUTA taxes due?
FUTA taxes come due one month after the quarter your business owes $500 or more in FUTA taxes, or on January 31 of the following year, whichever comes first.
If you have only a few full-time employees or many part-time employees, you might not collect $500 in FUTA taxes in one year. When that happens, you pay whatever you’ve collected by January 31 of the next year.
According to the example above, your business pays the $105.60 in FUTA taxes on January 31 of the following year since you did not collect $500 during the year.
If your business collected $100 in FUTA taxes in the first quarter of the year, $300 in the second quarter, and $200 in the third quarter, FUTA taxes would be due on October 31. That’s one month after the end of the third quarter, which is when the FUTA liability grew past $500 for the year.
It’s likely that your payroll software calculates and retains your FUTA liability and automatically remits it when the time is right.
How to report FUTA taxes for your small business
FUTA taxes are reported on IRS Form 940, which is due on January 31 each year. When your payroll software issues Form W-2 for each employee, it should send in Form 940.
If you do your own payroll and need to report these taxes yourself, have a record of your business’s payroll in front of you. Form 940 has you enter information about the state unemployment taxes paid to show that you qualify for the 5.4% tax credit.
Don’t forget about FUTA taxes
FUTA taxes often come to just 0.6% of each employee’s annual wages, but don’t ignore them. Keep your small business bookkeeping sharp so you never miss a payment.
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