Have you ever been fired or laid off by a previous employer? If so, then you were probably relieved to receive a weekly unemployment check while you were in between jobs. What you may not know is that unemployment compensation is partially paid by employers. So as a small business owner, if you terminate an employee, you may have to pay for a part of their unemployment compensation.
FUTA stands for Federal Unemployment Tax Act. FUTA is the federal fund to which employers must pay a portion of their unemployment taxes. Form 940 is the tax form that employers must file annually to report payments that they made for unemployment taxes. The form includes 7 sections and relies on consistent, comprehensive record-keeping.
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In this article, we will discuss your most frequently asked questions:
- What is FUTA and Form 940?
- Who Has to Pay FUTA Tax
- How Much FUTA Tax You Have to Pay
- When FUTA taxes are due
- How FUTA taxes are paid
- When to File Form 940 with the IRS
What is FUTA and Form 940?
Under the Federal Unemployment Tax Act (FUTA), employers have to pay a tax rate of 6% on the first $7,000 that each employee earns. The good news is that the amount you pay to the federal government can be reduced by the amount of unemployment tax that you pay to the state. Paying state unemployment taxes on time can reduce your FUTA taxes to as little as 0.6% on the first $7,000 each employee earns.
The IRS requires that you file Form 940 annually to report unemployment tax payments made to the FUTA fund. Later in this article, we will cover in more detail when to file Form 940 and the type of information that it asks for. You can also have your Form 940 filed automatically via a payroll software such as Gusto. Click here to try it for free.
Who Has to Pay FUTA Tax?
If you answer yes to either of the below questions, then you must pay FUTA tax:
- Did you pay wages of $1500 or more to employees in any calendar quarter during 2016?
- Did you have one or more employees for at least some part of a day in any 20 or more different weeks in 2016? (TIP: Be sure to count all full-time, part-time, and temporary employees).
Independent contractors are not considered employees. Therefore, you do not have to pay FUTA tax when you hire contractors. One of the reasons why small businesses hire contractors instead of employees is so that they don’t have to pay benefits and payroll taxes like FUTA. To learn more about when to hire a contractor vs. an employee click here.
How Much FUTA Tax Do I Have to Pay?
The FUTA tax rate is 6% on the first $7000 paid to each employee. If an employee’s wages exceed $7,000, you have no further tax liability.
If you pay your state unemployment taxes (called SUTA) on time and before your FUTA taxes are due, then the amount you must pay for FUTA is generally reduced to 0.6% on the first $7,000 paid to each employee.
This is because for most states, the Federal government allows a credit of 5.4% to offset what you pay in state unemployment taxes. This means the maximum FUTA liability for many businesses is $42 per employee ($7,000 * 0.6 % = $42). It doesn’t matter what your state tax rate is–the federal tax credit is the same.
To make matters easier, you can also use a payroll filing service that will calculate FUTA taxes for you and file form 940 on your behalf. Our recommended payroll filing service is Gusto. You can sign up today for a free 14-day trial to see how it can help you and your business.
Credit Reduction States
A state that has not repaid money it borrowed from the federal government to pay their unemployment benefits is called a credit reduction state. In these states, the amount of the credit that would normally be applied to federal unemployment tax payments made by employers is reduced, which results in higher FUTA taxes for employers.
For the 2016 tax year, California is the only state that is subject to a credit reduction. What this means for you is that if you paid wages in the state of California, then your FUTA tax will be 1.8% vs the rest of the US at 0.6%.
Because the FUTA credit reductions were just announced in November, businesses in California have been paying the standard 0.6% rate throughout the year. Now that the credit reduction has been formally announced, businesses in the state of California have until January 31, 2017 to pay their additional liability.
Refer to the summarized table below for the 2016 FUTA tax rates:
2016 FUTA Tax Rate By State
|State||2016 FUTA Tax Rate||Maximum FUTA Tax
|Rest of the U.S.||0.6%||$42|
State Unemployment Tax Rates
The state fund, SUTA, stands for State Unemployment Tax Act. The majority of unemployment tax is paid to your state fund with a small percentage (generally 0.6%) going to the FUTA fund. Since each state sets its own unemployment tax rates, the rates do vary from state to state as you can see from the table below.
Sample State Unemployment Tax Rates
|State||Unemployment Tax Rates||New Employer Rates|
|California||1.5-6.2%||3.4% (plus 0.1% employment training tax)|
|Massachusetts||0.73-11.13%||1.87% (plus 0.81% solvency assessment and 0.056% workforce training fund surcharge)|
States use a variety of complicated formulas to calculate each employer’s unemployment rate.
A common component in these formulas is the number of employees that are laid off or fired from your business who collect unemployment compensation. States often reward businesses with stable employment by assessing lower SUTA taxes on them, so the best way to reduce your SUTA taxes is to keep turnover to a minimum. For example, if you have an employee who is not performing well, try to find out what the issue is and see if it is something that you can help with before you fire them. Maybe there is an easy fix to the problem, or they just need some additional training.
Here is a great article on how to reduce SUTA costs by StaffMarket.com that provides great info on SUTA and goes into more detail on how to reduce your SUTA costs.
When are FUTA Taxes Due?
The deadline for paying your FUTA tax is based on the amount of your quarterly tax liability. If your FUTA tax is $500 or less in a quarter, you are not required to pay the taxes until they exceed $500. Therefore, you would carry the liability over to the next quarter. You will continue to carry the liability over until you exceed the required $500. Once you have reached that amount, you must pay your FUTA taxes based on the table below.
Summary Table of FUTA Tax Payments Due Dates
|If your undeposited FUTA tax is more than $500 on...||Your tax payment is due|
|March 31||April 30|
|June 30||July 31|
|September 30||October 31|
|December 31||January 31|
Example: Let’s say you are a New York-based business with 10 employees. Your total FUTA taxes are $420 on March 31 ($42 for each employee). You do not have to submit a FUTA payment yet because your taxes are below the $500 minimum. Let’s say by April 30, you hire 3 additional employees and have a total of $546 in FUTA taxes. Your payment is due on July 31 which is the next payment due date. On July 31, you would remit the $420 accumulated from the first quarter plus any additional tax accumulated in April, May, and June.
You will also have to meet your state’s reporting requirements and deadlines for SUTA tax payments and forms. For more information on what your state requirements are for SUTA, check out 2016 Payroll Tax Rates by state.
In order to qualify for the FUTA tax reduction for payment of state unemployment taxes, you must pay the SUTA tax by your state’s deadlines and before your FUTA taxes are due.
How are FUTA Taxes Paid?
Payments for FUTA taxes must be submitted through the Electronic Federal Tax Payment System (EFTPS). This is not the same as e-file for business, which is for submitting tax returns rather than making payments. To use EFTPS, you will need a Federal Employer Identification Number (aka EIN or FEIN). Apply for an EIN with the IRS here, or sign up for Gusto and let them take care of it. To learn more about EIN numbers, click here.
When Do You File Form 940 with the IRS?
Form 940 is due to the IRS once a year on January 31, for the preceding tax year. For example, tax deposits made in 2016 must be reported on Form 940 that is due on January 31, 2017.
If you are using a payroll software program like Gusto, Form 940 will automatically be completed for you. You can also file the form electronically and make any payments due through Gusto.
If you decide to complete the form manually, the IRS has detailed instructions that you can find here. Some of the info that you will need to include on the form are:
- General business information (EIN #, Business Name, & Mailing Address)
- State where you had to pay state unemployment tax
- Total wages paid to all employees
- Payments exempt from FUTA tax (e.g. Fringe benefits, retirement/pension). For more info, see Form 940.
- Total FUTA tax deposits made for the year
The Bottom Line
As you can see, there’s a lot that goes into calculating unemployment tax for both the federal and state authorities. You don’t want to do this kind of thing by hand. Therefore, I suggest you let a payroll software program like Gusto do the heavy lifting for you. Gusto is designed to manage end to end payroll which includes but is not limited to: calculating paychecks, printing payroll checks or making direct deposit payments, computing payroll tax liabilities like FUTA and SUTA, and completing the payroll tax forms like Form 940. Try it free for 1 month.
If you’re in the market for an accounting software program, check out QuickBooks Online. We have created a free course that provides you with step by step instructions on how to get your business up and running. In addition, QuickBooks integrates seamlessly with Gusto, our recommended payroll software. This will ensure that your financial statements are always up to date after each payroll run.