Federal Unemployment Tax Act (FUTA)

What is the Federal Unemployment Tax Act (FUTA)? 

The Federal Unemployment Tax Act (FUTA) is a U.S. federal law that requires payroll tax to businesses with employees. Passed in 1939, this tax is used to fund the federal government’s unemployment insurance programs and unemployment compensation benefits for eligible workers who have lost their jobs. According to this Act, employers must pay federal unemployment taxes quarterly or annually.

How much is the Federal Unemployment Tax Act (FUTA) tax rate? 

In 2021, the FUTA tax rate is 6% and applies to the first $7,000 the employer paid to each employee as annual wages. The responsibility of paying FUTA tax rests solely on the employer. It is not to be deducted from the paycheck of employees. 

Because FUTA tax is paid by the employer alone, this is what makes it different from other payroll taxes like Social Security and Medicare taxes which are paid by both employer and employee. 

Who is required to pay FUTA tax? 

The IRS has set specific requirements on which employers owe federal unemployment taxes. The FUTA tax is paid by employers who have paid wages of $1,500 or more to their employees in any calendar quarter. Additionally, an employer is also required to pay FUTA tax if they have one or more employees work for at least some part of a day in any twenty or more different weeks within the calendar year. For employers, keep in mind that all employees who are part-time, full-time, and temporary should be counted. In case the business is a partnership, the partners are not to be counted.

The FUTA tax is paid either annually or quarterly. The schedule will depend on how much FUTA tax is due. Aside from the FUTA tax, employers are also required to file Form 940 every year to report their FUTA tax payments. 

For employers of household employees, they are required to pay the FUTA tax on wages paid to household employees amounting to cash wages of $1,000 or more in a calendar quarter. A household employee is an individual who performs household work in a private home, local college club, or local chapter of a college fraternity or sorority. 

For agricultural employers, they are required to pay FUTA tax if they paid cash wages of $20,000 or more to farmworkers during a calendar quarter for the past two years. Also, if they employed ten or more farm workers during some part of the day during twenty or more different weeks for the past two years. 

Who is exempt from paying the FUTA tax? 

Generally, organizations that are exempt from income tax under section 501(c)(3) of the Internal Revenue Code are also exempt from paying FUTA. Organizations classified as 501(c)(3) organizations are usually those that perform religious, charitable, scientific, educational, and other types of work included in section 501(c)(3). They do not have to file Form 940. An organization must legally file for a 501(c)(3) status to the IRS. 

An employer is not required to pay the FUTA tax only if they paid an employee less than $1,500 in a calendar quarter or if they have not had an employee for twenty weeks or more within a calendar year. These two points are part of the general test. 

Are all nonprofit organizations exempt from paying FUTA tax? 

No, not all nonprofit organizations and groups are exempt from paying the FUTA tax. Only those that have duly filed to and have been given 501(c)(3) status by the IRS are exempt from paying FUTA. 

Is the Federal Unemployment Tax (FUTA) the same as State Unemployment Tax (SUTA)?

While the two have a similar purpose, they are not the same. There are U.S. states that collect both state unemployment and federal unemployment taxes from employers. In such cases, paying state unemployment taxes timely and in full can lessen the federal unemployment tax liability of employers. They can take a tax credit of up to 5.4% of taxable income. Meaning, for employers who qualify for the highest tax credit, the FUTA tax rate can be reduced to 0.6% after tax credit. 

How can you compute the FUTA taxes? 

As we have mentioned above, the present FUTA tax rate for 2020 is 6% which applies to the first $7,000 of wages paid to an employee during the calendar year. 

Let’s say your business owes FUTA tax and you are eligible for the maximum tax credit of 5.4%. After the tax credit, your FUTA tax due is 0.6% of the first $7,000 that each of your employees earns. Here is how you can calculate the FUTA tax liability:

• First, add all the wages paid to your employees counted in the FUTA tax during the reporting period:

Quarter 1

Lily was paid $5,000.

Jane was paid $7,000.

Cody was paid $2,000.

$4,000 + $7,000 + $2,000 = $14,000 of wages  for Quarter 1

• Multiply the sum of the quarterly wages of the employees counted in the FUTA tax by 0.6%.  Your business is eligible for the maximum tax credit of 5.4%.

$14,000 × 0.006 = $84

• $84 is your FUTA tax due for Quarter 1

For employers with FUTA tax due for the quarter that is $500 or less, the IRS allows you to carry this amount over to the next quarter until it reaches $500 or more.