FUTA is the Federal Unemployment Tax Act, and FUTA tax is the federal unemployment tax imposed under it. The employer pays all of it, and together with state unemployment tax systems the tax provides funds for paying unemployment compensation to workers who have lost their jobs (IRS, Instructions for Form 940). Only employers pay FUTA tax, and an employer must not collect or deduct FUTA tax from its employees’ wages (IRS, Instructions for Form 940).
The headline rate in the statute is not the rate most employers pay. Nearly all of it is given back as a credit for the contributions the employer paid into a state unemployment fund, so the federal charge that actually lands is small, and it is reported once a year rather than every quarter.
The Statute Imposes 6 Percent and Then Points at Definitions
The imposing provision is one sentence, and three of its terms are defined elsewhere. There is imposed on every employer, as defined in section 3306(a), for each calendar year an excise tax with respect to having individuals in his employ, equal to 6 percent of the total wages, as defined in section 3306(b), paid by that employer during the calendar year with respect to employment, as defined in section 3306(c) (26 U.S.C. 3301).
Reading it as a rate alone misses where the work is. Each of those three cross-references narrows the tax, and the first one decides whether a business owes it at all.
The base runs out early in the year. The tax applies to the first $7,000 paid to each employee during a calendar year, after subtracting any payments exempt from FUTA tax (IRS, Instructions for Form 940), and the statutory form of that exclusion, at 26 U.S.C. 3306(b)(1), is quoted in payroll tax.
Who Counts as an Employer
The definition is a set of thresholds rather than a description, and there are three of them for three kinds of work.
For purposes of the chapter, an employer is in general any person who, during any calendar quarter in the calendar year or the preceding calendar year, paid wages of $1,500 or more, or who on each of some 20 days during the calendar year or the preceding calendar year, each day being in a different calendar week, employed at least one individual in employment for some portion of the day. For purposes of that paragraph, no account is taken of any wages paid to, or employment of, an employee performing the domestic services referred to in paragraph (3) (26 U.S.C. 3306(a)(1)).
Agricultural labor runs on its own numbers. There the employer is a person who paid wages of $20,000 or more for agricultural labor in a calendar quarter of the year or the preceding year, or who employed at least 10 individuals in agricultural labor on each of some 20 days in different calendar weeks (26 U.S.C. 3306(a)(2)).
Domestic service in a private home, a local college club, or a local chapter of a college fraternity or sorority has a third test, a person who paid cash wages of $1,000 or more for that service in a calendar quarter of the year or the preceding year (26 U.S.C. 3306(a)(3)).
The three do not blend into one another. A person treated as an employer under the domestic service test is not treated as an employer with respect to wages paid for any service other than that domestic service, unless that person is treated as an employer under the general test or the agricultural one with respect to that other service (26 U.S.C. 3306(a)(4)). The general test reads the same way from the other side, since it disregards domestic service wages and employment when it counts (26 U.S.C. 3306(a)(1)). A household employer who also runs a small business does not automatically drag the business into FUTA.
The State Credit Is What Sets the Real Rate
Two credits sit against the tax and the second one carries most of the weight.
The first is for contributions actually paid into a state unemployment fund under a certified state law, which is set out in payroll tax. The second is an additional credit, equal to the amount, if any, by which the contributions the employer was required to pay for the taxable year were less than what it would have had to pay if throughout that year it had been subject under that state law to the highest rate applied in the certified 12-month period ending on October 31 to any person having individuals in his employ, or to a rate of 5.4 percent, whichever rate is lower (26 U.S.C. 3302(b)).
Then a ceiling sits over both. The total credits allowed to a taxpayer under the section shall not exceed 90 percent of the tax against which those credits are allowable (26 U.S.C. 3302(c)(1)).
The two are not the same rule. The 5.4 percent in subsection (b) caps the rate used to size the additional credit, while the 90 percent in subsection (c)(1) caps the credits added together. They land on the same number because, in applying subsection (c), the tax imposed by section 3301 is computed at the rate of 6 percent (26 U.S.C. 3302(d)(1)), and 90 percent of 6 is 5.4. What is left after a full credit is the number an employer with a clean state record actually pays.
Statutory rate, 26 U.S.C. 3301 6.0%
Maximum additional credit rate, 26 U.S.C. 3302(b) 5.4%
Ceiling on total credits, 26 U.S.C. 3302(c)(1) 90% of the tax
Left after a full credit 0.6%Rates per 26 U.S.C. 3301 and 26 U.S.C. 3302. The last line is the subtraction, not a separate statutory rate.
A Credit Reduction Takes Part of That Credit Back
The credit is not permanent, and what removes it is a state’s borrowing rather than anything the employer did.
Where an advance has been made to a state’s unemployment account under title XII of the Social Security Act and a balance is still outstanding, employers subject to that state’s unemployment compensation law lose part of their credit. In a taxable year beginning with the second consecutive January 1 on which a balance of those advances exists, the total credits are reduced by 5 percent of the tax imposed by section 3301 on wages attributable to that state. Each succeeding year with a balance still outstanding takes a further 5 percent (26 U.S.C. 3302(c)(2)).
A further reduction can sit on top of that one, and the statute writes it twice, for different stretches of years. For a taxable year beginning with the third or fourth consecutive January 1 on which a balance exists, the added amount is built from the state’s average annual wage in covered employment measured against the chapter’s wage base, and from the amount, if any, by which 2.7 percent, itself adjusted by that wage base over the estimated United States average annual wage in covered employment, exceeds the state’s average employer contribution rate for the preceding calendar year (26 U.S.C. 3302(c)(2)(B)). From the fifth consecutive January 1 onward a different formula applies, the amount, if any, by which the state’s 5-year benefit cost rate for the year, or 2.7 percent if that is higher, exceeds that same average employer contribution rate (26 U.S.C. 3302(c)(2)(C)). The later formula is switched off, and the earlier one applied in its place, for a year in which the Secretary of Labor determines on or before November 10 that the state meets the requirements of subsection (f)(2)(B) (26 U.S.C. 3302(c)(2)).
Two things follow for a firm doing the payroll. Which states are affected changes from year to year, because it turns on whether a balance still exists on a given January 1, and the reduction does not apply at all for a taxable year if there is no balance of those advances as of the beginning of November 10 of that year (26 U.S.C. 3302(d)(3)). And the extra money is due earlier than the return: in years when there are credit reduction states, liabilities owed for credit reduction must be included with the fourth quarter deposit (IRS, Instructions for Form 940).
Filing Is Annual, Depositing Is Not
Form 940 reports the annual FUTA tax, but the money can be due before the return is (IRS, Instructions for Form 940).
If FUTA tax is more than $500 for the calendar year, at least one quarterly payment must be deposited. If the tax is $500 or less in a quarter, it is carried over to the next quarter, and it keeps carrying until the cumulative amount is more than $500, at which point it is deposited for that quarter. A deposit is due by the last day of the month after the quarter ends (IRS, Instructions for Form 940).
That threshold is what makes FUTA feel invisible in a small practice. A business paying a handful of people at the full credit rate can run most of a year without a single deposit, and then meet the whole liability with the return.
Common Questions
No, and there is nothing to withhold. Only employers pay FUTA tax, and an employer must not collect or deduct it from employees’ wages (IRS, Instructions for Form 940). The tax is imposed on the employer with respect to having individuals in its employ, which is a charge on the act of employing rather than a share of anyone’s pay (26 U.S.C. 3301).
No. FUTA is a federal excise tax under the Internal Revenue Code. State unemployment tax is a contribution imposed by a state’s own unemployment compensation law, and the Code meets it mainly as the credit described above. The two are set separately, they run on different bases, and an employer usually pays both. The state side is covered in payroll tax.
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