The Federal Unemployment Tax Act (FUTA) is the federal fund to which all employers must pay a portion of their unemployment taxes, known as the FUTA tax. Employers must pay a tax rate of 6% on the first $7,000 that each employee earns. The IRS requires that all businesses report FUTA taxes on Form 940.
How to File Form 940 Quickly & On Time
Form 940 can be a nightmare for small businesses who forget to file them accurately and on time. Gusto is an affordable payroll service that can file all payroll taxes (including Form 940) automatically for your business. They offer a free 30-day trial.
How Does FUTA Tax and Form 940 Work?
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. This tax is paid quarterly and the Form 940 tax return is filed annually on January 31 for FUTA taxes owed and tax payments made in the previous year.
The good news is that the amount you pay to the federal government can be reduced by the amount of unemployment taxes you pay to the state. Paying state unemployment taxes on-time can reduce your FUTA taxes by as much as 5.4%, meaning that you can end up paying as little as 0.6% on the first $7,000 that each employee earns. We discuss this tax break in the section below.
Regardless of how much FUTA tax you actually pay, you MUST file your Form 940 annually to report unemployment tax payments you made to the FUTA fund. To make filing Form 940 and other employee tax forms easy and automatic, including paying the right amount of taxes, try Gusto, our recommended small business payroll service. They offer new customers a free 30-day trial.
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 $1,500 or more to employees in any calendar quarter during 2017?
- Did you have one or more employees for at least some part of a day in any 20 or more different weeks in 2017? (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 you can read our ultimate guide on when to hire a contractor vs. an employee.
How Much FUTA Tax Do You Have to Pay?
The FUTA 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. However, you’ll also have to pay state unemployment taxes (SUTA), and if you pay it on time each quarter before FUTA taxes are due, you can reduce your FUTA tax burden to 0.6%.
This is because in all states except for “credit reduction 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. However, your SUTA tax might vary depending on your state.
Credit Reduction States
Almost all states reward businesses that pay SUTA tax on time with a 5.4% reduction in FUTA taxes owed. However, a state that hasn’t repaid money borrowed from the federal government to pay for unemployment benefits is called a “credit reduction state.” In these states, the federal FUTA credit given to businesses is less than 5.4%.
For the 2017 tax year, employers in California & the Virgin Islands are subject to a credit reduction. What this means for you is that if you paid wages in the state of California or the Virgin Islands, your FUTA tax will be 2.1% vs the rest of the US at 0.6%.
Since the FUTA credit reductions were just announced in November 2017, businesses in California & the Virgin Islands 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 & the Virgin Islands have until January 31, 2018, to pay their additional liability.
You will report and pay this tax when you file Form 940 in January. Refer to the How to Complete Form 940 section below. Refer to the summarized table below for the 2017 FUTA rates for businesses who qualify for the federal tax credit that we have discussed.
2017 FUTA Rate By State for Businesses with Federal Tax Credit
|Rest of the U.S.|
How Much SUTA Tax Do You Have to Pay?
The state fund (SUTA) stands for State Unemployment Tax Act. The majority of unemployment tax owed 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.
Below, we have provided a few sample SUTA tax rates for 4 states. As you can see, the rates for a brand new employer tend to be higher than a seasoned business.
Sample SUTA Tax Rates
|State||SUTA Tax Rates for Existing Business||SUTA Tax Rates for a New Business|
|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)|
A new business is one incorporated during the current reporting year while an existing business is one that’s been around for more than 1 year.
States use a variety of complicated formulas to calculate each employer’s unemployment rate. For more information on the rates in your state, check out 2017 payroll tax rates by state. SUTA tax varies not only by state but also by business within the state.
For example, 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.
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 perhaps they just need some additional training.
Here is a great article on how to reduce SUTA costs by StaffMarket.com. It provides great info on SUTA and goes into more detail on how to reduce your SUTA costs.
When are FUTA Taxes Due?
FUTA taxes are due 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 taxes until they exceed $500. If you don’t reach $500 for the year, you must pay what you owe when you file Form 940 on January 31.
Once you exceed $500 in FUTA taxes due, you must pay your taxes based on the table below:
FUTA Tax Payment Due Dates
|If Undeposited FUTA tax is more than $500 on...||Tax payment is due on...|
|March 31, 2017||April 30, 2017|
|June 30, 2017||July 31, 2017|
|September 30, 2017||October 31, 2017|
|December 31, 2017||January 31, 2018|
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 now 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.
SUTA Tax Payment Due Dates
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 2017 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). You can visit EFTPS.gov to enroll online or complete Form 9779 and mail it to the address on the form. Within 7 days of enrollment, you will receive the information that you need to set up and pay your FUTA taxes online. To use EFTPS, you will need a Federal Employer Identification Number (EIN or FEIN).
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 2017 must be reported on Form 940 due on January 31, 2018. Form 940 is basically a reconciliation of the amount of FUTA tax owed each quarter, less any quarterly payments that were made.
We will show you how to complete form 940 later on in this article. However, 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.
How Do You Complete Form 940?
There are 6 primary sections of Form 940. Below, you will find a snapshot of a sample Form 940 and a brief description of the information required for each section.
FUTA Form 940 Example:
FUTA Form 940 Instructions
- General Info – In this section, you will provide general info about your business such as business name & address and your federal tax id (EIN).
- Part 1– In part 1 of the form, you need to indicate whether or not you paid in unemployment tax in one state or multiple states. In addition, you must indicate if one of the states is a credit reduction state.
- Part 2– The goal of part 2 is to calculate the total FUTA tax that you owe. To do so, you will need to provide total wages paid to all employees and wages paid in excess of $7,000 per employee. Refer to the IRS instructions for Form 940 for additional details.
- Part 3 – In this section, you will provide info related to any wages that you did not include in your SUTA tax payments as well as any late SUTA tax payments; any wages falling into one of these two categories is not eligible for the 5.4% credit. Any wages paid in a credit reduction state will be calculated on Schedule A Form 940 and carried over to line 11 of Form 940.
- Part 4 – The purpose of this section is to reconcile the total FUTA tax owed with the quarterly payments that have been made. If the amount due on line 14 is over $500, you must remit payment no later than January 15; any amount due under $500 can be submitted when you file the return on or before January 31.
- Part 5 – In this final section, you must provide the total FUTA tax liability for each quarter. Note: Only if your total liability reported on line 12 is more than $500. If it’s not, no need to complete this section.
If you need a better understanding regarding the info you need to properly record your payroll and how/when to report and pay your payroll taxes, check out our payroll guide for best practices.
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 can of course do it yourself, but this can be time-consuming and confusing. You’ll have to pay your quarterly payments on-time and accurately file Form 940 in a timely manner.
To avoid penalties and interest, we recommend you let a payroll software program like Gusto do the heavy lifting for you. Gusto will calculate tax liabilities like FUTA and SUTA, and complete payroll tax forms like Form 940. Try it free for 1 month.