What Is IRS Form 940?
Businesses with employees file IRS Form 940 to report their obligations under FUTA—the Federal Unemployment Tax Act. Form 940 shows the amount of federal unemployment taxes the employer owed the previous year, how much has already been paid, and the outstanding balance. The form is due January 31, or February 10 for businesses that have already deposited their unemployment taxes in full.
Businesses with employees are responsible for paying unemployment taxes. These taxes fund unemployment benefits for people who lose their jobs. Unlike other taxes, these taxes are not withheld from employees’ wages. The employer alone is responsible for paying unemployment taxes and reporting them on IRS Form 940.
Small business owners often find this form confusing. This is because, along with the federal government, states levy unemployment taxes through the State Unemployment Tax Act (SUTA). State unemployment taxes affect your federal tax liability, so you have to understand both FUTA and SUTA pretty well in order to file Form 940.
Read on to understand how to fill out each part of the form, as well as when to file it and how to pay your taxes. As a small business owner, you might not like thinking about taxes, but understanding your responsibilities will help you stay in the clear with the IRS and keep more of your hard-earned profits.
In This Article
- FUTA and SUTA Taxes
- Who Has to File IRS Form 940
- When and How to File Form 940
- How to Fill out Form 940
- State Unemployment Taxes
- IRS Form 940 and Unemployment Taxes
FUTA and SUTA Taxes
IRS Form 940 is used to report unemployment taxes that employers pay to the federal government under the Federal Unemployment Tax Act (FUTA). FUTA taxes are used to fund unemployment benefits for people who are laid off or lose their jobs through no fault of their own.
States also require businesses to pay unemployment taxes through SUTA, the State Unemployment Tax Act. States administer unemployment insurance funds with the SUTA taxes they collect and with the FUTA taxes that the federal government passes on to them.
For 2019, the FUTA tax rate is 0.6% on the first $7,000 in wages for each employee—equivalent to $42 per employee per year. Businesses that file state unemployment taxes late or that operate in credit reduction states have to pay a higher percentage, up to 6% on the first $7,000 in wages. SUTA tax rates can vary between anywhere as low as 0.05% or as high as 14%, depending on the state.
Who Has to File IRS Form 940?
You must report your FUTA tax liability by filing IRS Form 940 each year. In general, any business that answers yes to one or both of these questions has to pay FUTA taxes and file Form 940:
- Did you pay $1,500 or more in wages to employees during any calendar quarter of the current year or previous year (e.g. if you’re filing your 2019 tax forms, then look at 2019 thus far and 2018)?
- Did you employ one or more individuals for at least some part of a day in any 20 or more different weeks in the current year or previous year?
When determining whether you fall into either of these categories, you should count all full-time, part-time, and temporary employees—basically anyone who receives a W2 form. This includes the owner’s salary if you have a corporation or LLC. However, you shouldn’t count 1099 independent contractors or business partners in a partnership.
Special Form 940 Rules
Certain types of businesses face special rules for filing Form 940.
Individuals with household employees, such as nannies or maids, must pay FUTA taxes only if they paid $1,000 or more in wages in any one calendar quarter. But instead of filing Form 940, you would file Schedule H along with your personal income tax return.
Agricultural employers must pay FUTA taxes and file Form 940 if they paid $20,000 or more in wages to employees during any quarter in the current or previous calendar year. Alternatively, you also have to file if you employed 10 or more farm workers during some part of the day in the current or previous calendar year.
Family-owned businesses have special rules in terms of which wages are subject to FUTA taxes. You don’t have to include wages of children under the age of 21. However, you should include older children, as well as spouses, if your business is structured as a corporation or partnership.
Educational, religious, or charitable institutions and other nonprofit organizations that aren’t subject to taxation under Section 501(c)(3) of the federal tax code don’t have to pay FUTA taxes and don’t have to file Form 940.
When and How to File Form 940
For most businesses, the deadline for filing Form 940 is January 31, or the next business day if January 31 happens to fall on a weekend. However, the deadline for filing Form 940 is distinct from the deadline for paying unemployment taxes. Businesses that have already paid their unemployment taxes in full have until the second Monday of February to file Form 940.
Businesses that owe $500 or less in FUTA taxes can pay their taxes when filing Form 940. However, businesses that owe more than $500 must pay their FUTA taxes on a quarterly schedule. If your FUTA tax is $500 or less in a quarter, roll it over to the next quarter. Continue rolling over your tax liability until the cumulative tax is more than $500. At that point, you must deposit your tax for the quarter by the following due dates:
|If cumulative tax is more than $500 on…||Deposit your taxes by…|
You can pay your FUTA taxes on the Electronic Federal Tax Payment System (EFTPS). Keep track of your payments because you’ll need them to complete your Form 940 correctly. Your Form 940 can be filed on paper or e-filed if you use a tax preparer.
How to Fill out Form 940
There are seven parts to IRS Form 940. Most sections are pretty straightforward. Parts 1 and 3 sometimes trip up small business owners because some math is required to sync up your state and federal unemployment tax payments.
Here are step-by-step instructions for filling out IRS Form 940:
In the top section, you’ll have to provide some basic information about your business, including your business name, address, and employer identification number (EIN). Thomas Richardson, Tax Manager at CPATax, points out that disregarded entities should use the owner’s social security number or tax ID, not the business’s tax ID.
Indicate whether you employ workers in only one state or in multiple states, and whether you paid wages in a credit reduction state.
If you only employed people in one state, note that state’s postal abbreviation in question 1a. Employers with employees in multiple states have to pay SUTA taxes in each of those states. Multi-state employers should check the box under question 1b of part 1 and fill out Schedule A (Form 940).
If you have employees who live in one state but work in another, you’ll need to follow the Department of Labor’s multi-state employer test to figure out which state’s SUTA taxes to pay:
- Localization: Where the employee performs the job.
- Base of Operations: Where the employee receives instructions and next assignments.
- Place of Control: The state from which the management and control over the employee originate.
- Residence: Where the employee lives and performs some services (if other three factors don’t yield a clear answer).
This test typically requires you to pay taxes in the state where the employee performs the work or receives assignments. After applying the test, if you’re unsure about where to pay your SUTA taxes, you should speak to a tax professional.
Credit Reduction States
Credit reduction states are states that have borrowed money from the federal government to shore up their unemployment compensation funds but failed to pay back the full amount. In that case, the credit you can claim on your FUTA taxes declines. In other words, instead of paying a 0.6% FUTA tax rate, you could pay up to 6% on the first $7,000 in wages per employee.
Fortunately, credit reduction is not something that most small business owners have to work about. In 2018, the only credit reduction state was the U.S. Virgin Islands, with a 2.4% credit reduction. The DOL maintains an up-to-date list of credit reduction states.
If at the time of filing, your state is a credit reduction state, check the box under question 2 of part 1, and fill out Schedule A (Form 940).
Part 2 allows you to calculate your total FUTA tax liability. You start by noting your entire year’s worth of payroll. Then, exclude wages that you paid in excess of $7,000 for each employee. You should also exclude fringe benefits, retirement benefits, life insurance payments, and other types of benefits that are exempt from FUTA taxes. Fringe benefits are things like employer-paid travel and dining.
Excluding wages beyond the $7,000 base and any exempt wages and multiplying by 0.6% will tell you your total FUTA tax liability for the year before adjustments.
Part 3 of Form 940 accounts for any adjustments in your FUTA tax liability as a result of paying state unemployment taxes. If you paid state unemployment taxes late, or if any of the wages that you paid to employees were exempt from state unemployment taxes, you’ll need to pay a higher-than-normal share of FUTA taxes. This is to prevent an employer from getting a windfall simply if they operate in a state which levies lower unemployment taxes. Complete the worksheet in Form’s Instructions to determine the exact adjustments you’ll need to make.
Remember, if you’re in a credit reduction state, you’ll also pay higher FUTA taxes. For businesses in a credit reduction state, enter the total from Schedule A onto line 11 of Form 940.
Part 4 is where you calculate your total FUTA tax liability (line 12) and whether you have an outstanding balance (line 14). In line 13, note any taxes that you’ve already deposited for the year.
If the balance on line 14 after those deposits is $500 or less, you can pay the tax along with filing Form 940. There is a payment voucher included with Form 940 for convenience, or you can pay online if you’re e-filing. If the balance after the deposits is more than $500, you have to deposit your tax separately according to the quarterly schedule shown above.
If you’re a quarterly depositor and overpaid your FUTA taxes, indicate at line 15 how you wish to receive your money back.
If the yearly amount of FUTA taxes that you owe is greater than $500, you must break down your balance by quarter in part 5. The total on line 17 when you add up each quarter should equal the total tax liability on line 12.
Part 6 lets you authorize your accountant, employee, or another third party to discuss this filing with the IRS.
This is the signature section. If you used a tax preparer to complete the form, they should sign in this section as well.
If you face additional questions when filing form 940, we recommend consulting a tax professional.
According to Richardson of CPATax, “If filing solo is the plan, then ensure that all total payroll amounts, or gross pay, are calculated properly, that employee payments that exceed $7,000 for the year are subtracted, and that payments not included in unemployment tax liability are subtracted. Believe it or not, having an error and then needing a professional, like me, to fix it costs more.”
State Unemployment Taxes
As we mentioned earlier, most employers have to pay both FUTA and SUTA taxes.
The confusing part is that states can have their own rules for which businesses have to pay SUTA taxes. And if you do have to pay taxes, your state could have a different payment schedule, different payment deadlines, and different reporting forms.
And of course, SUTA tax rates vary significantly by state. The tax rate could be as low as 0.05% or as high as 14% depending on the state. Most states set a lower, new employer rate to encourage startups and then increase the rate from there based on your company’s turnover and employment history.
Your accountant or tax professional should be able to assist you with finding out your state requirements and with filing Form 940 and any related state forms. Tax Foundation also has a map summarizing the SUTA tax burden in each state.
IRS Form 940 and Unemployment Taxes
Businesses have many tax responsibilities, among them paying unemployment taxes. Your FUTA tax payments need to be recorded with the IRS, which is why you have to file Form 940 on time. This is the government’s way of verifying that you met your obligations as an employer.
Fortunately, paying FUTA taxes and reporting them on Form 940 is fairly straightforward if you understand how state and federal payments work together. If you have any questions about FUTA taxes or how state unemployment taxes affects your FUTA tax payments, it’s best to get assistance from a tax advisor, payroll service, or professional employer organization (PEO). These services can simplify and automate tax filing, so you can focus more energy on running your business.