I still remember the January panic call from a small manufacturing client – they had three employees in a state that had just been flagged for a FUTA credit reduction, and nobody on their payroll team had caught it until we were building the 940 together. The difference wasn’t huge, but the surprise was. That moment stuck with me, because Form 940 is one of those filings that looks simple right up until it isn’t.
Key Takeaways
- Form 940 is the Employer’s Annual Federal Unemployment (FUTA) Tax Return, filed once per year to reconcile unemployment tax obligations and claim state credit reductions.
- Who files: Any employer who paid wages of $1,500 or more in any calendar quarter, or had one or more employees for at least part of 20 or more weeks during the year.
- Due date: January 31 following the tax year. If all FUTA deposits were made on time and in full, the due date extends to February 10.
- FUTA rate: 6.0% on the first $7,000 of each employee’s wages. Most employers claim a 5.4% state credit, netting 0.6% – but credit reductions in certain states can raise that effective rate.
- Key pitfall: Missing Schedule A (Form 940) when employees work in credit-reduction states is a common preparer error that triggers IRS notices.
- SOP tip: Lock down your state credit-reduction state list every November, before the filing season, so you aren’t caught off-guard in January.
What Form 940 Is and When to Use It
Form 940 is the IRS’s mechanism for employers to report and reconcile their federal unemployment tax (FUTA) liability each year. While Form 941 handles quarterly payroll tax deposits including Social Security, Medicare, and withheld income tax, Form 940 is dedicated entirely to FUTA – the federal side of unemployment insurance.
FUTA works differently from FICA taxes in one important respect: it is paid entirely by the employer. There is no employee withholding. The tax funds the federal unemployment trust fund, which backs state unemployment insurance programs during periods of high claims. Employers in all 50 states, D.C., and most U.S. territories must participate.
Who Must File
You must file Form 940 if you meet either of the following tests during the calendar year. The general test applies if you paid wages of $1,500 or more in any calendar quarter to employees in covered employment, or if you had one or more employees for at least some part of a day in any 20 or more different weeks. The 20-week count includes weeks when any one employee was on payroll, and part-time, temporary, and seasonal workers all count.
Separate triggering rules apply to household employers (who pay cash wages of $1,000 or more in any calendar quarter to household employees) and to agricultural employers (who paid $20,000 or more in cash wages in any calendar quarter or had 10 or more agricultural workers in any 20-week period). Both groups file Form 940 but check the appropriate box at the top of the form.
Relationship to State Unemployment Tax (SUTA)
Most employers pay both federal and state unemployment taxes. The FUTA system is designed so that employers who pay their state unemployment taxes on time receive a credit of up to 5.4% against the 6.0% federal rate. That credit brings the net FUTA cost down to 0.6% on the first $7,000 of wages per employee. If your state qualifies for the full credit and you paid SUTA on time, that’s the rate your clients should be budgeting. From my side of the desk, I always model the FUTA deposit calendar using the 0.6% rate – but flag credit-reduction states in the workflow for manual review.
When Form 940 Is Required Despite No Current Employees
If you had employees in the prior year but not in the current year, you may still need to file. The IRS expects a final return if employment ceased mid-year. Check the “Final: Business closed or stopped paying wages” box on the form and include the closing date. Skipping this step is one of the things that leads to IRS inquiry letters years later.
How to Complete Form 940, Section by Section
The form is shorter than it looks, but each section feeds into the next. Walking through it in order prevents the most common errors.
Header and Employer Information
Enter the EIN, legal name, and trade name (if different). Check the appropriate type box: if you paid FUTA wages only in one state, enter the state abbreviation in box 1a. If you paid wages in multiple states, check box 1b and you’ll need to complete Schedule A.
Part 1 – Tell Us About Your Return
Lines 1a and 1b capture your state reporting situation. Line 2 is checked if you paid wages to household employees. Line 3 is checked if you paid wages subject to state unemployment tax in any state listed on Schedule A as a credit-reduction state. Get these right before moving to Part 2 – they affect your credit calculation downstream.
Part 2 – Determine Your FUTA Tax Before Adjustments
| Line | Description | Practitioner Note |
|---|---|---|
| 3 | Total payments to all employees | Pull from payroll register; include all compensation |
| 4 | Payments exempt from FUTA | Retirement plan contributions, dependent care, health insurance – common exemptions |
| 5 | Total payments over $7,000 per employee | FUTA wage base caps at $7,000 per person; excess is excluded here |
| 6 | Subtotal (line 4 + line 5) | Auto-calculated; verify against payroll summary |
| 7 | Total taxable FUTA wages (line 3 − line 6) | Should match your payroll system’s FUTA wage report |
| 8 | FUTA tax before adjustments (line 7 × 0.06) | Gross tax at 6%; most will get credit against this in Part 3 |
Part 3 – Determine Your Adjustments
This section handles two scenarios. Line 9 applies if all FUTA wages were excluded from state unemployment tax – in that case the full 5.4% credit is disallowed, and you multiply taxable wages by 0.054. Line 10 applies if some wages were excluded from SUTA (e.g., wages paid to certain corporate officers in some states). Line 11 is the credit-reduction adjustment from Schedule A – this is where multi-state complexity lands.
Part 4 – Determine Your FUTA Tax and Balance Due or Overpayment
Line 12 is FUTA tax after adjustments. Line 13 is your total FUTA deposits made during the year through EFTPS. Line 14 is balance due. Line 15 is overpayment, which can be applied to next year or refunded. Quick rule you can copy into your SOP: cross-reference quarterly deposit amounts against what you entered in EFTPS before finalizing line 13. A single transposed digit here causes a mismatch notice.
Part 5 – Report Your FUTA Tax Liability by Quarter
This section is only required if line 12 exceeds $500. Report the FUTA liability (not deposits) for each quarter. The IRS uses this to verify that deposits were made correctly throughout the year. Many practitioners confuse “liability” with “payment” here – they are different. Liability accrues when wages are paid; deposits are made at quarterly intervals if the cumulative balance exceeds $500.
Schedule A – Multi-State Employers and Credit Reductions
If you paid wages in more than one state, or if any state you paid wages in is a credit-reduction state, Schedule A must be attached. The IRS publishes the list of credit-reduction states each fall (typically via Revenue Procedure). For each credit-reduction state, multiply taxable FUTA wages paid there by the applicable reduction percentage. The total flows to line 11 of Form 940. This is a step that many multi-state payroll files skip, and it almost always results in a CP2000 or balance-due notice.
Deadlines, Penalties, and Filing Requirements
| Event | Due Date | Notes |
|---|---|---|
| Form 940 annual filing | January 31 | For the prior calendar year |
| Extended deadline (if deposits current) | February 10 | All FUTA deposits made on time and in full |
| Q1 FUTA deposit (if liability > $500) | April 30 | Via EFTPS |
| Q2 FUTA deposit (if liability > $500) | July 31 | Via EFTPS |
| Q3 FUTA deposit (if liability > $500) | October 31 | Via EFTPS |
| Q4 FUTA deposit or final payment | January 31 | Due with or before the return |
Deposit Rules
FUTA taxes are deposited quarterly using EFTPS, but only when the cumulative liability exceeds $500. If your FUTA liability at the end of a quarter is $500 or less, you carry it forward to the next quarter. At year-end (Q4), any remaining balance must be either deposited by January 31 or remitted with the return. Deposits cannot be made by check directly with the form.
Failure-to-File and Failure-to-Deposit Penalties
| Penalty Type | Rate | Notes |
|---|---|---|
| Failure to file | 5% per month, max 25% | Based on unpaid tax; minimum $435 or 100% of tax if smaller |
| Failure to deposit – 1–5 days late | 2% | Of the amount not deposited on time |
| Failure to deposit – 6–15 days late | 5% | |
| Failure to deposit – 16+ days late | 10% | |
| After IRS first notice | 15% | If amount not deposited within 10 days of IRS notice |
| Accuracy-related penalty | 20% | If underpayment due to negligence or disregard of rules |
Electronic Filing Threshold
Employers who file 10 or more information returns during the year are required to file electronically. Most payroll platforms – including ADP, Gusto, QuickBooks Payroll, and Paychex – handle 940 e-filing natively. If you’re preparing for small employers manually, confirm whether paper filing is still permitted for their situation. The IRS has been progressively tightening e-file requirements.
FUTA Credit Reductions – The Part Most Preparers Underestimate
The state credit reduction is the single most misunderstood aspect of Form 940, and it generates more IRS notices than almost any other FUTA filing error. Here’s the mechanics: when a state has an outstanding balance on federal unemployment trust fund loans, the IRS reduces the 5.4% FUTA credit for employers in that state. The reduction starts at 0.3% in the first year and increases by 0.3% each additional year the loan is outstanding, subject to some caps and exceptions.
From my side of the desk, I treat credit-reduction state status as a firm-wide planning flag, not a filing detail. By November, we pull the IRS announcement (usually Revenue Procedure) identifying which states have outstanding loans, update our payroll tax matrix, and communicate the effective FUTA rate to any affected clients before year-end. That gives them time to budget the additional liability rather than being surprised by it in January.
Which States Are Commonly Affected
California and New York have historically appeared on the credit-reduction list in recent years due to the volume of unemployment claims and borrowing during economic downturns. Virgin Islands has been a perennial credit-reduction territory. The list changes annually, and the reduction percentages vary. Always check the IRS announcement for the filing year rather than relying on prior-year data – small errors create big cleanup.
How to Calculate the Schedule A Amount
For each credit-reduction state where you paid wages, identify the total FUTA-taxable wages paid to employees in that state. Multiply by the applicable reduction rate. Sum across all credit-reduction states and carry the total to Form 940, line 11. The schedule itself is organized by state, so if you have employees in California with $200,000 in FUTA-taxable wages and the credit reduction is 0.9%, your Schedule A amount for California is $1,800.
FUTA Exemptions – What Wages Are Not Subject to the Tax
Not all compensation is FUTA-taxable. Understanding the exemptions reduces your client’s tax liability and avoids the reverse problem of under-reporting taxable wages.
Common FUTA-Exempt Payments
- Employer contributions to qualified retirement plans – 401(k), SEP-IRA, SIMPLE IRA employer contributions are not FUTA wages
- Group-term life insurance premiums for coverage up to $50,000
- Employer-paid health insurance premiums
- Dependent care assistance up to the statutory limit
- Workers’ compensation payments
- Certain payments to family members – payments to children under 21 employed by a parent, or to a spouse, are exempt from FUTA (but check your state SUTA rules, which differ)
- Payments to statutory non-employees – real estate agents and direct sellers classified as statutory non-employees are exempt
The $7,000 FUTA Wage Base
The federal wage base for FUTA has been $7,000 per employee per year since 1983 and has not been indexed for inflation. This means for any employee earning more than $7,000 annually, FUTA tax stops accruing after the first $7,000 is paid. High-wage employers with stable workforces often have their entire annual FUTA liability satisfied by mid-Q1. The practical implication: deposit monitoring can wind down earlier in the year once all employees have exceeded the wage base.
How FUTA Interacts With Other Payroll Returns
Form 940 does not exist in isolation – it sits within a payroll tax compliance stack that includes Form 941 (quarterly federal payroll tax), state unemployment returns (SUI/SUTA), and Form W-2 year-end reporting. Errors in one often create downstream issues in another.
Reconciling FUTA With Form 941 and W-2 Data
At year-end, your total wages on all W-2s should reconcile with your total payroll reported across four 941s. The FUTA taxable wage figure on Form 940 line 7 will be lower than total W-2 wages because of the $7,000 wage base cap and exempt payments. Build a reconciliation schedule for each client that shows: total W-2 wages minus FUTA exemptions minus wages over $7,000 equals FUTA taxable wages. If this doesn’t tie out, something is wrong before you file.
State SUI Returns and the 5.4% Credit
To claim the full 5.4% FUTA credit, the employer must have paid state unemployment tax on time. “On time” means by the due date of Form 940 (January 31, or February 10 if extended). Late SUTA payments can cause a partial disallowance of the credit even if the amount was ultimately paid. This is particularly relevant for clients who let their SUTA accounts fall behind during the year and catch up in Q4 or early January.
Common Mistakes That Slow Things Down
- Forgetting Schedule A for multi-state employers – if any employees work in more than one state, Schedule A is required even if no state is a credit-reduction state. Attach it or expect a notice.
- Reporting deposits instead of liabilities in Part 5 – Part 5 asks for tax liability by quarter, not deposit amounts. Many preparers enter the wrong figure, which causes an IRS matching error.
- Missing the credit-reduction adjustment on line 11 – if you have employees in a credit-reduction state, failing to complete Schedule A and carry the amount to line 11 results in an underpayment.
- Including wages over the $7,000 wage base in taxable wages – not subtracting excess wages from line 3 overstates FUTA liability and either generates an overpayment or causes the client to deposit more than necessary.
- Claiming the 5.4% credit when SUTA was paid late – partial credit disallowance is real. Verify SUTA payment dates before applying the full credit on line 10.
- Not filing a final return when employment ends – if a business closes or stops paying wages, the final 940 should be marked with the closing date and the “Final return” box checked to stop IRS follow-up requests.
- Using the wrong EIN – FUTA deposits made under one EIN and a return filed under a different or incorrect EIN cause deposit mismatches that take months to resolve.
Practical Checklists You Can Reuse
Copy these into your internal wiki or SOP.
Pre-Filing Preparation Checklist
- Confirm the filing year and employer EIN
- Pull payroll register with total wages, exempt payments, and per-employee FUTA wage base amounts
- Identify all states where wages were paid
- Check IRS credit-reduction state list for the filing year
- Verify all SUTA payments were made on time and obtain payment confirmation
- Gather EFTPS deposit records for all four quarters
- Check if household or agricultural employee rules apply
- Confirm whether business closed or stopped paying wages mid-year
Form 940 Review Checklist
- Total wages on line 3 reconcile to W-2 totals
- FUTA-exempt payments are properly identified and documented on line 4
- Wages over $7,000 per employee are correctly excluded on line 5
- Schedule A is attached if wages paid in multiple states or any credit-reduction state
- Line 11 credit-reduction amount ties to Schedule A total
- Part 5 quarterly liability figures match payroll records (not EFTPS deposit amounts)
- Line 13 total deposits match EFTPS payment history
- Balance due or overpayment is correctly computed on lines 14 and 15
- “Final return” box checked if business closed
Year-End FUTA Compliance Checklist
- November: pull IRS credit-reduction state announcement and update client matrix
- November: verify all Q3 SUTA payments are current
- December: confirm Q4 FUTA liability amount for deposit planning
- January 1: calculate final year FUTA tax and deposit if Q4 balance exceeds $500
- January 15: send client a FUTA reconciliation showing expected balance due
- January 31: file Form 940 (or February 10 if all deposits current)
- Post-filing: retain payroll register, EFTPS records, and SUTA payment confirmations for minimum 4 years
For Accounting Firms – Keep Delivery Smooth While You Scale
Payroll tax compliance – including Form 940 – is one of those practice areas where volume creates pressure fast. When a firm manages payroll compliance for 40 or 60 clients, the January 31 deadline becomes a production event, not just a calendar date. Missed credit-reduction adjustments, mismatched EFTPS deposits, and late Schedule A attachments all increase with volume if you don’t have a disciplined review workflow behind each filing.
Accountably works with CPA and EA firms to build structured offshore delivery for payroll tax, bookkeeping, and tax return production – so your experienced staff focus on review and client communication rather than data entry and first-pass preparation. We keep this mention brief on purpose, your process comes first.
FAQs About Form 940
What is IRS Form 940 used for?
Form 940 is the Employer’s Annual Federal Unemployment (FUTA) Tax Return. Employers file it once per year to report their federal unemployment tax liability, claim the credit for state unemployment taxes paid, and reconcile any balance due or overpayment. The tax funds the federal side of the unemployment insurance system.
Who must file Form 940?
Any employer who paid wages of $1,500 or more in any calendar quarter, or who had at least one employee for any part of a day in 20 or more different weeks during the year, must file Form 940. Household employers and agricultural employers have separate threshold tests. Sole proprietors, partnerships, and corporations with employees all fall under these rules if the thresholds are met.
When is Form 940 due?
Form 940 is due January 31 following the close of the calendar year. If all required FUTA tax deposits were made on time and the full amount was paid, the due date extends to February 10. No automatic extension is available for the return itself, though deposits are made quarterly throughout the year via EFTPS.
What is the net FUTA tax rate?
The gross FUTA rate is 6.0% on the first $7,000 of each employee’s wages. Employers who paid their state unemployment taxes on time receive a credit of up to 5.4%, bringing the net rate to 0.6% for most employers. Employers in credit-reduction states pay a higher effective rate, with the reduction published annually by the IRS each fall.
What happens if you miss the Form 940 deadline?
Late filing triggers a penalty of 5% of the unpaid tax per month, up to a maximum of 25%. There is a minimum penalty of $435 if the return is more than 60 days late. Separate failure-to-deposit penalties apply if quarterly FUTA deposits were not made on time, ranging from 2% to 15% depending on how late the deposit was.
Can Form 940 be amended?
Yes. If you discover an error after filing, use Form 940-X to correct it. Common reasons for filing an amended return include discovering that a credit-reduction state applied and was not reported, finding an error in wages reported, or correcting a deposit misallocation. File Form 940-X as soon as the error is identified – the sooner it is corrected, the lower the penalty exposure.
This article is educational, not tax advice. Rules change, and states differ. Confirm thresholds, deadlines, and elections against the current IRS instructions for your year and facts.