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The Federal Unemployment Tax Act (FUTA) is a payroll tax, reported on IRS form 940, that businesses must pay annually or quarterly to fund unemployment benefits for employees who lose their jobs. The FUTA rate for most businesses is 0.6% of the first $7,000 of wages. Most businesses also have to comply with their state’s State Unemployment Tax Act (SUTA), which coordinates with the federal tax.
Small business owners have numerous business tax obligations, among them federal and state unemployment taxes. The Federal Unemployment Tax Act (FUTA) is used to fund unemployment compensation for employees who lose their jobs. The State Unemployment Tax Act (SUTA) serves the same purpose in each state. Most businesses have to pay both FUTA and SUTA taxes.
Calculating your FUTA and SUTA tax rates can be confusing to first-time business owners. Even if you’re an established business owner, you might have trouble making these calculations, especially if you have multiple business locations or employ remote workers. Figuring out when the taxes are due and how to file and pay them can be even more confusing.
In order to avoid fines and keep your tax rates low, it’s important to understand your FUTA and SUTA tax obligations. Read on to find out how to calculate your tax rate, determine exemptions and credits, and file and pay your unemployment taxes.
Unemployment insurance provides payments to employees who are laid off or lose their jobs through no fault of their own. The money for unemployment insurance payments comes from employer-paid federal and state unemployment taxes. Unlike Social Security and Medicare payroll taxes, which are divided evenly between employers and employees, employees do not pay unemployment taxes. Employers do not withhold these taxes from their employees’ paychecks.
Both the federal government and state governments collect unemployment taxes from employers. The federal government sends its portion to the states to supplement what the states collect.
Any business that falls into either of these criteria must pay FUTA taxes:
In general, you do not have to pay FUTA or SUTA taxes on your own income, unless your business is structured as a corporation. If you have a family-run corporation or partnership, your child’s wages (if 21 or older) and spouse’s wages count for FUTA and SUTA purposes.
The tests for household and agricultural employees are slightly different from the test above. And SUTA requirements vary by state, so it’s best to contact your state’s unemployment tax agency to find out if you have to pay SUTA taxes. Certain types of businesses, such as nonprofits, religious institutions, and educational institutions, are exempt from paying FUTA and SUTA taxes.
FUTA and SUTA tax rates are calculated based on the amount of an employee’s wages, up to a certain limit. The rates and wage limits can change periodically.
Jennifer Affrunti, a CPA and controller at Nussbaum Yates Berg Klein & Wolpow, PC, says “It is worth noting that the wage base and rates for FUTA have not increased… for quite a while. While there is nothing definitive right now, there are discussions in the works that would reinstate [higher taxes] sometime in the future.”
The 2019 FUTA tax rate is 6% on the first $7,000 in wages that you paid to an employee during the calendar year. After the first $7,000 in annual wages, you don’t have to pay taxes. For example, the FUTA tax for an employee who receives $6,000 in annual wages would be $360. The FUTA tax for an employee who receives more than $7,000 in annual wages would be $420.
The federal government usually grants a credit of 5.4% to business owners who have paid their state unemployment taxes on time. This effectively brings the FUTA tax rate down to 0.6%.
Unfortunately, if your business in a credit reduction state, you can’t claim the full 5.4% credit. Credit reduction states are states that have not repaid the federal government for money that they borrowed to fund unemployment insurance payments. The Department of Labor (DOL) maintains an updated list of credit reduction states.
In 2018, the Virgin Islands was the only credit reduction state. Employers paying Virgin Island SUTA taxes have a credit reduction of 2.4% in 2018, meaning that their final FUTA rate comes to 3% instead of 0.6%.
Depending on the state, SUTA rates range from as low as 0.05% to as high as 14%. Wage bases also vary by state. Many states charge lower rates for new businesses, and higher rates for high-turnover industries like construction. Established businesses receive a rate based on experience. The “experiencing rating” and resulting SUTA rate will change based on the level of turnover and history of unemployment claims from your former employees.
Once you apply for and receive your employer identification number (EIN), you can set up a SUTA tax account—called a state unemployment insurance (SUI) account in some states—with your state’s unemployment tax agency. The agency will notify you about your SUTA rate and wage base, and update you when these change.
The U.S. Department of Labor has a four-part test for multi-state employees (employees who work in one state and live in another) and businesses with remote employees. You can use these to determine which state you must remit your tax to. You must consider each of the following:
In practice, the test usually means that you have to pay unemployment taxes in the state where the employee works and performs services most of the time. Some states have reciprocal agreements with nearby states, allowing employers to file and pay the taxes to the state where the business is located.
The form used to report FUTA taxes is IRS Form 940. This form is due by January 31 of each year (or the next business day if this falls on a weekend). But the catch is that the due date for filing Form 940 and the due date for actually paying the taxes are different. If you pay your taxes on time, the deadline for filing Form 940 gets extended to the second Monday in February.
According to Affrunti, a common mistake is thinking that “FUTA requires an annual filing. Employers sometimes mistake their payment liability, and may assume the payment is always due with the filing. Once an employer’s liability reaches $500, however, they are required to submit the tax on a quarterly basis. If you do not pay it in time, you could incur penalties.”
If you expect your total FUTA tax liability to be greater than $500 for the year, you must deposit your taxes on a quarterly basis. If your FUTA tax liability for the quarter is lower than $500, then roll over that amount to the next quarter. Once your total FUTA tax liability in a quarter (including rolled over amounts) reaches $500, then you should deposit your payment no later than the last day of the following quarter.
Those due dates are as follows:
Payments should be made on the electronic federal tax payment system (EFTPS).
If your total FUTA tax liability is under $500 for the year, you don’t have to deposit your FUTA taxes quarterly. You can either choose to be a quarterly depositor or to pay your taxes once per year when you file Form 940.
SUTA tax filing deadlines might differ from the federal, so it’s best to contact your state unemployment agency to learn the details for your business.
Paying FUTA and SUTA taxes is unavoidable. Most businesses have to pay these taxes. The good news is that the tax burden is usually relatively low compared to other payroll taxes and income taxes.
Here are some best practices to keep your FUTA and SUTA taxes low:
Whether you pay FUTA or SUTA taxes annually or quarterly, it’s important to pay on time. If you fail to pay on time, the IRS and your state unemployment agency will sock you with fees. The IRS penalties for late payment of employment taxes range from 2% to 25%, depending on how late you are. Those are completely avoidable fees as long as you stick to deadlines.
One thing to keep in mind is that both FUTA and SUTA taxes are calculated from a wage base. The FUTA wage base is $7,000. That means you only have to pay FUTA taxes on the first $7,000 of an employee’s annual wages. This also means that every time you hire someone new, the FUTA wage base kicks in anew.
Say you have a customer service associate who’s paid $40,000 per year. If the same person has occupied that role for the last year, you’ve only paid $42 in federal unemployment taxes for that employee (plus additional state taxes). But if you’ve hired four different people for that role in the last year, then you’ve quadrupled your FUTA tax burden to $168.
The key is to be a great employer and keep your employee turnover as low as possible. If your budget is tight, avoid layoffs and try to increase cross-departmental transfers. These types of strategies will keep your SUTA taxes low.
As we mentioned above, your SUTA tax rate is based on your company’s employment history. Companies with high levels of turnover and large numbers of unemployment claims have to pay higher SUTA taxes. To keep rates down, you should respond to unemployment claims as soon as they’re filed.
Most claims for unemployment insurance are legitimate, but you should always respond if there appear to be any questionable claims. Most states give employers the opportunity to appeal a claim for unemployment compensation. If anything appears fishy (e.g. the employee provides the wrong termination date or states the wrong salary), you should respond as soon as possible. Blocking fraudulent unemployment claims will keep your SUTA rates low.
Paying FUTA and SUTA taxes is pretty straightforward, at least if all your employees live in the state where your business is located. Things get trickier when you have businesses with multiple locations, remote employees, or employees who work in one state while living in another (common near state borders).
In those cases, using a small business payroll service or a professional employer organization (PEO) can simplify things. Payroll providers and PEOs will automate your employment taxes. With a few clicks and some information about your workforce, they’ll make sure to file the right forms on your behalf and send the right payments.
PEOs go an additional step further. PEOs pool together many small businesses and act as a co-employer to everyone who works in those businesses. Some states use the experience rating of the PEO, rather than the small business, to calculate SUTA rates. That can be very helpful to a business that has experienced a lot of turnover. You essentially get to piggyback off the larger size and lower turnover of the PEO, resulting in lower SUTA rates.
A lot of small businesses turn away at the mention of the word “taxes.” Fortunately, FUTA and SUTA taxes are relatively low compared to other business taxes. The IRS rules for paying FUTA taxes are pretty straightforward, and the federal government and most states allow for online tax payment.
The FUTA tax rate is standard for most businesses—0.6% on the first $7,000 in annual wages. What you have more control over is your SUTA tax rate. You can keep your SUTA tax rates low by filing on time and simply being a good employer that your workers want to stay with long term. And if you need some extra help, a payroll service or PEO can be invaluable.