When you run a business, you have to pay taxes on the wages you pay your employees. But, trying to calculate and track the various payroll taxes you owe can be confusing. You might even wonder, “What’s the point of all this?”
Payroll taxes support state and federal government programs such as Medicare, Social Security, and state unemployment benefits. Medicare and Social Security payments get grouped under FICA taxes, and unemployment benefits are funded by taxes like FUTA.
Read on to learn what FUTA taxes are, who they apply to, and how to pay them.
What Is the FUTA Tax?
FUTA stands for the Federal Unemployment Tax Act. This federal law created a fund to provide unemployment benefits to people who are laid off or fired. The federal government, however, doesn’t administer unemployment—states do. That’s why FUTA funds go toward each state’s unemployment program.
What Is the FUTA Tax Rate?
The FUTA tax rate is 6%, and it only applies to the first $7,000 of an employee's wages for the entire year. You don’t pay FUTA taxes on any salary after that first $7,000.
In other words, the maximum amount of FUTA taxes you pay is $420 (6% of $7,000) per qualifying employee annually.
Who Has To Pay FUTA Taxes?
Only employers have to pay FUTA taxes, unlike FICA taxes (for Social Security and Medicare). In other words, you don’t withhold any FUTA taxes from your employees.
What's more, only certain employers need to pay these employment taxes. So do you have to pay FUTA taxes? Most likely, yes. The Internal Revenue Service (IRS) uses three methods to decide if you need to pay FUTA taxes. It uses a general method for general employees and special methods for employers who hire household or agricultural employees.
Most small business owners fall in the general category, which says you need to pay FUTA taxes for an employee if:
- You paid that employee $1,500 or more (in wages) during any calendar quarter in the previous or current year, or
- The employee worked at least 20 or more different weeks in the current or last year—this includes full-time, part-time and temp workers.
That first rule applies to individual wages, not your company’s total taxable wages. So if you have three temp workers who each earn $1,000 per quarter, and your quarterly payroll is $3,000—you don’t have to pay FUTA taxes since none of your employees make more than $1,500.
What’s more, the general method only applies to employees that get a regular salary or W-2 wages. You don’t have to pay FUTA taxes if you hire an independent contractor.
Household and agricultural employers can use the additional tests in IRS Publication 15, Employers Tax Guide, to see if they have to pay FUTA taxes.
Self-employed individuals, such as independent contractors and freelancers, do not have to pay FUTA taxes on their income.
How Do I Calculate My FUTA Tax?
Need to figure out your team's FUTA taxes so you can make the right payments to the IRS? Here's a simple formula to follow:
FUTA Tax = FUTA Tax Rate x Taxable Wage Limit
For 2023, that means:
FUTA Tax = 6% x $7,000
Let's say you have a team member who earned $15,000 this quarter alone. Since this tax only applies to the first $7,000 of wages in a year, you'd calculate their FUTA tax as follows:
FUTA Tax for an Employee = FUTA Tax Rate x Taxable Wage Limit
FUTA Tax = 6% x $7,000
That means you'd owe the IRS $420 for that one employee every year. You can do this process for each team member to figure out the total amount you owe Uncle Sam every quarter or year (more on when these taxes are due later!).
FUTA Tax for Employee Making More than $1,500 but less than $7,000
What if someone you hired made less than $7,000? As long as they made more than the lower limit, which is $1,500 or they worked 20 weeks or more for you, you'll still owe FUTA taxes for them.
For example, let's say you have a team member who made $2,000 last year (perhaps you hired someone, and had to quickly let them go). You'd still do the same formula, but it would look like this:
FUTA Tax = FUTA Tax Rate x Wages
= 6% x $2,000
So you'd need to eventually send Uncle Sam $120 in taxes for that employee.
Sound complicated? Let Hourly take payroll taxes off your hands. Their full-service payroll platform can automatically calculate payroll taxes and file them on your behalf.
FUTA Tax Credit
If you pay state unemployment taxes (SUTA), you may be eligible for a tax credit of up to 5.4%, making your FUTA tax rate 0.6%. State unemployment programs are sometimes called state unemployment insurance (SUI), and your payments may be referred to as contributions.
The formula to figure that out is:
FUTA Tax = (FUTA Tax Rate - 5.4% Tax Credit) x $7,000
= (6% - 5.4%) x $7,000
= .06% x $7,000
Generally, you can apply the full credit if you paid all your SUTA taxes in full and on time, and your state is not a credit reduction state.
Well, you’re probably wondering if you’re in one of those states, eh? As of 2022, there are no credit reduction states. However, the following states are at risk of credit reductions if outstanding loan amounts are not repaid:
- New Jersey
- New York
States can take out a Federal Unemployment Trust Fund loan if they can’t pay unemployment benefits. After two years, a state that has not paid back the loan becomes a credit reduction state until the loan is repaid.
You can check with the Department of Labor website to see if you’re in a credit reduction state and keep an eye out for states at risk for credit reduction in the current tax year.
So, let’s say you find out you’re in a state with credit reduction status. What kind of FUTA tax will you be paying?
You’ll essentially have to add your state’s credit reduction rate back into your calculations. For example, let’s say you live in a state with a credit reduction rate of 0.6%, and you paid your SUI taxes in full and on time.
Since you made payments in full and on time, you can take the maximum credit and subtract 5.4% from 6.0% to get a 0.6% FUTA tax rate. Then, you add back your state’s credit reduction rate of 0.6% to get a final tax rate of 1.2%.
When are FUTA Taxes Due?
So, if figuring out your FUTA rate isn’t always straightforward, at least there’s one deadline for everyone, right? Unfortunately, that’s not the case. If you have to pay FUTA taxes, your deadline depends on how much you owe.
Here’s how it breaks down:
- Employers who owe $500 or more each quarter must make quarterly tax payments.
- Employers who owe less than $500 per quarter carry over their FUTA tax liability to the next quarter until they owe more than $500. Once you owe more than $500, you pay the full amount of taxes you owe so far, including the amounts you rolled over from the previous quarters.
- Employers who owe $500 or less for the whole year can pay their total annual FUTA taxes by the Q4 deadline of Jan. 31.
Quarterly payments are due on the last day of the month following the end of each quarter. For instance, Q1 ends on March 31, so the FUTA taxes for Q1 are due on or before April 30.
The full quarterly deadlines are:
- Q1 taxes are due Apr 30
- Q2 taxes are due Jul 31
- Q3 taxes are due Oct 31
- Q4 taxes are due Jan 31 (of the following calendar year)
How To Make FUTA Tax Payments
FUTA payments must be made electronically. You can deposit them using the Electronic Federal Tax Payment System (EFTPS), a free service offered by the IRS.
When using EFTPS, you must schedule payments by 8 p.m. the night before the due date to give the system enough time to transfer the funds from your bank account.
Filing Form 940
Now that you’ve paid your FUTA taxes, you’re done, right? Not yet, you also have to report how much you paid. Every year that you pay FUTA taxes, you have to file IRS Form 940, also known as the Employer’s Annual Federal Unemployment Tax Return.
For most employers, Form 940 is due by Jan. 31. However, if you sent in all your tax payments on time throughout the year, you have until Feb. 10 to file Form 940. If your due date falls on a weekend or a holiday, the due date becomes the next business day.
Form 940 can be e-filed or mailed to the IRS. To find the correct mailing address for your state, refer to the IRS Instructions for Form 940. Late filing can result in a 2-15% fee on your total FUTA tax amount, depending on how late you submit the form.
If you pay FUTA taxes in a credit reduction state, you’ll need to file Schedule A (Form 940) to calculate your rate.
Wrapping it Up: What to Know About FUTA Taxes
The FUTA tax was created to support funds for state unemployment benefits. Unlike FICA taxes, employers are responsible for paying the entire FUTA tax amount—it’s not split with employees.
If you’re a small business with a few or more employees, you’ll most likely pay quarterly FUTA taxes. It’s easiest to pay electronically, and don’t forget you need to report that total amount to the IRS every year too—with Form 940.
So now that you know all there is to know about FUTA taxes—all that’s left to do? Start setting those funds aside!