Navigating the nuances of federal employment regulations is a must for any business. It helps companies reduce their tax burden and avoid penalties, and contributes to a stable economic environment where everyone thrives.
In the United States, this includes understanding and complying with the Federal Unemployment Tax Act (FUTA), which enforces a payroll tax on employers to fund benefits for workers laid off without cause.
In this guide, we'll explain what FUTA is, how to ensure your organization is in compliance, and how to proactively manage your unemployment tax commitments to minimize your liability.
What is FUTA?
FUTA mandates that all U.S. employers contribute to the Unemployment Trust Fund, a system managed by the Internal Revenue Service (IRS). The IRS then distributes these contributions to individual states to support workers who have lost their jobs through no fault of their own, such as layoffs, company restructurings, or closures.
Established in 1939 in response to the widespread unemployment of the Great Depression, FUTA continues to serve as a vital safety net for U.S. workers, assisting them during periods of unemployment.
Employers must pay a standard FUTA tax rate of 6% on the first $7,000 earned by each employee annually, which equates to a maximum of $420 per employee. However, employers who pay their state unemployment taxes fully and on time are generally eligible for a significant reduction in their FUTA tax rate. This can decrease the FUTA tax to as little as 0.6% on the first $7,000 of an employee’s earnings, or just $42 per employee per year, effectively reducing the burden to a tenth of the original rate.
Who pays FUTA tax?
Generally, any employer paying more than $1,500 in wages and salaries within a quarter is required to pay FUTA tax. This threshold casts a wide net, making almost all private-sector employers subject to FUTA tax.
There are specific types of employment with different criteria for FUTA tax obligations, including:
- Agricultural employers: Those in the agriculture sector, like farms, must pay FUTA taxes if they have paid at least $20,000 in wages during any calendar quarter or if they have employed 10 or more farm workers on any day of each week for at least 20 weeks in a year.
- Household employers: Individuals employing domestic help, such as housekeepers or nannies, must also pay FUTA taxes if they pay these employees $1,000 or more in wages within a quarter.
However, some organizations are exempt from FUTA and state-level unemployment taxes. These exemptions apply to nonprofits with 501(c)(3) status and religious institutions, including churches, mosques, and synagogues.
Native American tribal governments and federal, state, and local government entities—including public school districts—are also exempt from FUTA taxes.
FUTA vs. SUTA
While FUTA provides a standardized national distribution framework, the State Unemployment Tax Act (SUTA) structures vary from state to state, which allows states to adjust their rates depending on local needs. For example, New Jersey's SUTA tax rates range from 0.6% to 6.4%, while Arizona’s is much broader (0.07%–18.78%). SUTA taxes also often consider the employer’s history with unemployment claims, but employers can usually reduce their FUTA tax liability by paying their state-level (SUTA) taxes in full and on time.
FUTA vs. FICA
Like FUTA, the Federal Insurance Contributions Act (FICA) also plays a significant role in the U.S. federal payroll tax system, but they serve distinct purposes and operate under different rules.
FUTA is solely the employer's responsibility, but FICA taxes are shared between employers and employees to fund Social Security and Medicare, two of the most important social insurance programs in the U.S.
Under FICA, the employee and employer contribute 6.2% of the worker's gross earnings for Social Security and 1.45% for Medicare, doubling the contribution rates to 12.4% and 2.9%, respectively.
Social Security contributions under FICA are subject to an income cap, which is set at $168,600 for the current year—earnings above this threshold are not subject to further Social Security taxes. However, there is no cap for the Medicare portion. This system provides retirement benefits, disability insurance, and healthcare services for people 65 and older and those with certain medical conditions.
How to calculate FUTA tax liability
To determine how much your FUTA tax is, let's break down the process step by step for two hypothetical employees.
Employee A earns $10,000, and employee B earns $5,000 for the year:
1. Calculate the taxable amount for each employee
- For employee A, the taxable amount is $7,000 (since $7,000 is the cap)
- For employee B, the taxable amount is $5,000 (since they earn less than the $7,000 cap)
2. Apply the FUTA tax rate
- For employee A, 6% of $7,000 = $420
- For employee B: 6% of $5,000 = $300
3. Calculate total FUTA tax before credits
- Total FUTA tax liability is $420 + $300 = $720
4. Adjust based on credits for state unemployment taxes (though this may differ slightly from state to state, we’ll assume the employer qualifies for the maximum rebate of 5.4% because they paid their SUTA taxes in full and on time)
- For employee A, the new FUTA tax is 0.6% of $7,000 = $42
- For employee B, it’s 0.6% of $5,000 = $30
Therefore, the total FUTA tax liability for the employer is $72.
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