What is FUTA?

FUTA stands for the Federal Unemployment Tax Act, and it’s one of the taxes employers have to pay as part of payroll taxes.

FUTA taxes fund federal unemployment insurance, which is a government program that provides temporary financial support through unemployment benefits to eligible employees after they’ve been terminated due to no fault of their own. An eligible worker will typically receive FUTA wages each week from the unemployment insurance fund until that worker is once again employed or has exhausted the covered time period.

How does FUTA work?

Any employer who doles out wages of over $1,500 to employees within a calendar year is required to pay FUTA taxes on those wages annually. It’s important to remember that FUTA tax is paid in addition to State Unemployment Tax (known as SUI tax or SUTA which stands for State Unemployment Tax Act); employers must pay both as part of their payroll taxes.

The FUTA tax rate is 6% of an employee’s wages up to $7,000—any amount above the taxable wage base of $7,000 is not considered taxable wages for FUTA.

Who pays for unemployment insurance?

First, let’s briefly review unemployment insurance: Unemployment insurance (UI) is a joint federal and state program; this program provides a fund. In the event that a worker is terminated from their employment through no fault of their own, that fund will pay out cash benefits for a certain period of time to that worker. The UI fund is made up of two parts:

• FUTA – funded solely by the employer (meaning: this is not withheld from employee wages) and collected as FUTA tax

• SUTA – typically funded solely by the employer and collected as SUTA tax (SUTA is collected from both employers and employees in only three states: New Jersey, Pennsylvania, and Alaska)

As mentioned earlier, both FUTA and SUTA are collected as taxes; these taxes are:

• Collected while a worker is employed and end when the employee is terminated; and

• Documented on the employees’ paychecks each pay period.

Does my business need to pay unemployment insurance taxes?

If you own a small business, you may think you are exempt from FUTA—but that’s likely not the case. Before making any assumptions, you should know that you are required to pay both federal and state unemployment insurance (FUTA and SUTA) taxes if your business:

1. Has paid $1,500 or more in wages to employees (including both part-time and full-time employees) in any calendar quarter; or

2. Had at least one employee any day of a week for 20 or more weeks in a calendar year. These weeks do not have to be consecutive.

The purpose of this post is to cover FUTA (federal unemployment taxes), but, as mentioned earlier, the second part of unemployment insurance is composed of SUTA (state unemployment insurance), and each state has its own rules and regulations—including specifications on which wages are taxable, which employees are eligible, and the requirements of a business. In order to remain compliant, it’s critical that you understand your state’s requirements so be sure to check your state’s Department of Labor website.

Note that 501(c)(3) nonprofits that are exempt from income tax are exempt from FUTA tax liability, but still have state-level obligations (i.e., either paying SUTA or reimbursing states for any unemployment benefits that were paid to former employees).

In addition, if you’re an agricultural employer, you’re subject to FUTA under the following scenarios:

• You paid farmworkers $20,000 or more in any calendar year, or

• During 20 or more different weeks, you employed at least 10 farmworkers even for part of a day, irrespective of whether at the same time.

Do I need to pay FUTA taxes on the wages of part-time workers?

If your part-time employee receives more than $1,500 in wages within a calendar year, yes; you owe FUTA taxes on that employee’s wages (up to $7,000).

Do I need to pay FUTA taxes on the wages of independent contractors?

No. Independent contractors aren’t eligible to receive unemployment insurance so their wages are not taxable for FUTA.

I’m self-employed. Do I need to pay FUTA?

Nope. There is no FUTA tax for self-employed individuals, and, as mentioned above, there is no need to pay FUTA on any compensation you provide to independent contractors.

What are my unemployment insurance tax rates?

As a reminder: Unemployment insurance taxes are made up of both FUTA (the federal unemployment insurance tax) and SUTA (the state unemployment insurance tax).

Your unemployment insurance tax rates are set at both the federal and state levels.

FUTA (federal unemployment insurance taxes): The current federal unemployment insurance tax rate is 6% and applies to the first $7,000 paid to each employee (called the “wage base”) during the year.

However, employers and business owners who file and pay state unemployment taxes on time, will likely earn a 5.4% federal tax credit, which means that your actual FUTA rate will be 0.6% if you get the maximum credit, bringing your maximum payment per employee down considerably. How did we arrive at 0.6%? Simple: 

Here’s an example from the Internal Revenue Service (IRS) on how the credit adjusts your FUTA tax liability:

Let’s say you had three employees during your first quarter …

• Mary (earned $11,000, but only the first $7,000 is subject to FUTA tax)

• George (earned $2,000)

• Jane (earned $4,000)

The total wages subject to FUTA tax for the first quarter for the three employees equals $13,000 (i.e., $7,000 for Mary + $2,000 for George + $4,000 for Jane).

But when you factor in the maximum 5.4% credit using the 0.6% tax rate (that is $13,000 x .006), your FUTA tax liability for the first quarter is $78 for the three employees.

SUTA (state unemployment insurance taxes): Each state uses a different tax rate and wage base for their unemployment tax. Visit your state’s Department of Labor website to find out what they are where your company is based.

Can my unemployment insurance tax rate change?

Short answer: yes. 

Let’s break it down.

FUTA (federal unemployment insurance taxes): While it is possible that the FUTA rate may change from year to year, it has been at 6% since 2011. But, you should be sure to check IRS webpage on FUTA each year to confirm the rate.

Here’s the wildcard: you may live in what is called a credit reduction state. What’s that, you say? Certain states have taken out loans from the federal government in order to adequately fund unemployment compensation; if one of these states has not repaid the loan to the federal government within the required timeframe, that state is known as a credit reduction state.

How does operating in a credit reduction state affect employers and FUTA tax rates? Well, remember how we described the FUTA tax credit in the section above? If you operate your business in a credit reduction state, you will not be eligible for a 5.4% credit—even if you pay your FUTA taxes on time. Your FUTA credit will be reduced 0.3% for every year the loan is outstanding.

SUTA (state unemployment insurance taxes): SUTA tax rates are limited within a range—the range varies from state to state and is likely to change each year. A number of factors influence SUTA tax rates, so be sure to confirm your state’s SUTA rate at the start of each year in order to plan appropriately.

How to report and pay for FUTA taxes

This can get a little confusing because although FUTA taxes are only reported (filed) with the IRS once a tax year, they are paid quarterly. Here’s how to do both:

How to report FUTA taxes

The due date to report FUTA is January 31 of the year following the previous year (so FUTA taxes for tax year 2023 will be reported on January 31, 2024). In order to report FUTA, employers must fill out and file IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return; step-by-step details on how to fill out Form 940 is in this post. The tax return should be mailed to the IRS or filed online with one of these IRS-approved e-file providers.

If you have an agricultural business employing farmworkers, you must file Form 943.

How to pay FUTA taxes

FUTA taxes made in quarterly payments. If the FUTA taxes you owe exceed $500 within the quarter, they must be deposited quarterly. If the tax amount owed is less than $500, then you are not required to pay within the quarter but you must track the total amount of FUTA taxes owed, and when that cumulative amount reaches $500, you will be required to deposit the taxes. You can make your FUTA tax deposit using the Electronic Federal Tax Payment System (EFTPS).

Which employees are eligible for unemployment insurance after they’re terminated?

Employees who were terminated for no fault of their own (typically in circumstances like a layoff) are eligible for federal unemployment. In general, employees are not eligible for unemployment insurance if they are terminated for cause or quit their job. There are some variations per state, however, so be sure to check with a local HR expert.

What happens when an employee claims unemployment insurance?

When an employee claims unemployment insurance, you’ll receive a “Notice of Unemployment Insurance Claim Filed” from your state’s unemployment office. (Here’s an example from California).

This form is your state’s attempt to:

• Establish that your ex-employee is in fact eligible for unemployment insurance; and

• Discover how much the ex-employee has and will be paid in order to determine the amount of money to pay out each week.

If you agree that your former employee is eligible, then complete the form so the state can begin sending checks to your ex-employee.

In some cases, however, you might want to contest an unemployment insurance claim.

Why would I contest an unemployment insurance claim?

If you believe your former employee is not eligible for unemployment compensation, you may choose to contest the unemployment insurance claim. Keep in mind that if you protest the claim, you should have documentation that substantiates your reasoning as to why the former employee is ineligible–along with documentation on why you terminated the employee. 

Is FUTA related to FICA?

FUTA and FICA are part of payroll taxes. Payroll taxes are made up of the following Here’s how these breakdown:

Employee payroll taxes:

• FICA taxes (Social security and Medicare taxes)

• Income taxes (federal, state, and local income taxes)

• Unemployment insurance taxes (SUTA only for New Jersey, Pennsylvania, and Alaska)