What is FUTA tax? Understanding these employer taxes is an important responsibility you have as a business owner. Even if you have a bookkeeper that helps you with all your taxes, you should know everything about your business and the taxes it has to pay.
This post will help you understand this tax, what are its benefits, who pays FUTA tax, how to file this type of tax, and if it has any tax credit to reduce the amount your business owes.
Quarterly Taxes vs Annual Taxes: Which Ones Do You Have to Pay?
What is FUTA Payroll Tax? FUTA tax definition
FUTA means Federal Unemployment Tax Act. It is one of the payroll taxes employers have to pay.
The Federal government uses money collected from businesses through the Federal Unemployment Tax Act to provide unemployment benefits or compensation to individuals who are out of work.
However, only employers pay the tax on behalf of their employees. Why? Business owners don’t deduct the FUTA employer tax from employees’ wages.
Is it the same as Social Security?
FUTA taxes are not the same as Social Security. Employers report and pay this unemployment tax separately from Federal Income tax, and Social Security and Medicare taxes
Who Pays FUTA tax?
Any employer must pay federal unemployment taxes if they paid at least $1,500 in wages during any calendar quarter in the current or previous year.
As stated above, you should know that employees do not pay FUTA taxes; only employers do.
The maximum wage base for computing the Federal Unemployment Tax is the first $7,000 of each employee’s gross pay. Therefore, when an employee’s salary exceeds $7,000, the IRS doesn’t charge FUTA to the excess of over $7,000.
Does My Business Need to Pay Unemployment Insurance Taxes?
There are 3 guidelines the IRS established so you know whether your business is required to pay unemployment insurance taxes.
- Employees are not household or agricultural employees.
- You paid $1,500 in wages to employees in at least one calendar quarter per year.
- You paid employees (full time, part-time, and temporary) that worked some part of a day in at least 20 or more different weeks.
Who is Exempt from Paying FUTA Tax?
Most businesses are required to pay unemployment insurance taxes. However, government employers and nonprofit religious, charitable, and educational institutions are exempt from paying this tax.
How Much is the FUTA Tax?
When learning what is FUTA, you need to know that its tax rate is only for the first $7,000 paid to each employee.
What is the FUTA tax rate?
The FUTA tax rate for 2021 is 6% of the wages that any employer pays to an employee during the calendar year.
That means that as of 2020, the most FUTA tax you will pay is $420 per employee ($7,000 x 6%). If an employer also pays state unemployment taxes, they may claim a credit for up to 5.4% of taxable FUTA wages. This means you only pay 0.6% of the FUTA tax.
When states lack funds to pay unemployment compensation, they can borrow money from the Federal government and the Federal Unemployment Tax Act funds.
States that are unable to repay the loan are considered credit reduction states. As a result, employers in those states receive a reduced FUTA employer tax rate.
Therefore, you can adjust the total amount you owe on taxable wages based on exclusions and credit reductions which can vary per state.
Make sure to pay all your taxes to avoid an IRS audit.
When is FUTA Tax Due?
Knowing what is FUTA also means knowing that these taxes are quarterly. The IRS charges penalties and interest when you fail to make payments on time.
Each deposit is due the last day of the month after each quarter ends. For example, the first quarter ends in March, so you must make the deposit by the last day in April.
When to File Taxes: Tax Deadlines
How To Make FUTA Tax Payments?
Any time your unemployment tax act FUTA tax is $500 or more, you must deposit by EFT (electronic funds transfer, since you cannot mail payments to the IRS). If your deposit is less than $500, you can carry it over to the next quarter or whenever the total amount is $500 or more.
When you apply for an EIN to register your business, the IRS automatically pre-enrolls you in their Electronic Federal Tax Payment System. If you don’t have an account, you can contact the IRS at EFTPS.gov.
FUTA Tax Form
In addition to making quarterly FUTA tax deposits, you must file Form 940.
The FUTA tax form is an annual summary of taxable wages, exemptions, exclusions, credit deductions, and tax deposits you made the previous year and file with the IRS on January 31st of each year.
You can e-file Form 940 or refer to the form’s instructions on where to mail your report. If you owe tax, the IRS allows you to use a credit or debit card to pay any tax you owe when you file Form 940.
How to Calculate FUTA Tax?
Knowing what is FUTA is not the only important thing here; you also need to understand how to calculate it. Fortunately, learning how to calculate FUTA tax is very easy.
Remember: FUTA tax is only 6% of the first $7,000 each employee makes.
One way to calculate how much is 6% is to divide the employee’s wages ($7,000 or less) between 100 (which would tell you how much 1% is) and then multiply the result by 6 (to get 6%).
$7,000 ÷ 100 = 70
70 x 6% = $420
6% of $7,000 is $420
An easier way is just to multiply the salary by 0.06.
$7,000 x 0.06 = $420
But, what happens if you pay SUTA (State Unemployment Tax Act) and are eligible for the FUTA tax credit? Then you only have to pay 0.6% of this payroll tax. So, how do you calculate that?
You just multiply the salary by 0.006. So:
$7,000 x 0.006 = $42
See? Calculating the FUTA tax is quite easy.
How to Calculate FUTA Tax? An example
So, let’s say you have 5 employees and these are their salaries:
- Jack: $6,200
- Mark: $5,000
- Melissa: $7,000
- Zoey: $6,200
- Kate: $5,700
Fortunately, you can apply for the tax credit, so you just have to pay 0.6% of the salaries. So:
- Jack: $6,200 x 0.006 = $37.2
- Mark: $5,000 x 0.006 = $30
- Melissa: $7,000 x 0.006 = $42
- Zoey: $6,200 x 0.006 = $37.2
- Kate: $5,700 x 0.006 = $34.2
Then, all you have to do is sum up these numbers ($37.2 + $30 + $42 + $37.2 + $34.2), which would total $180.6.
How to Keep FUTA Taxes Low
Keep accurate records
When you track payments made to employees, you ensure that you don’t overpay the tax.
Amounts over the first $7,000 of wages paid to an employee are exempt from taxation. If you use payroll software, you should calculate your FUTA tax for each payroll, so you know when to stop paying FUTA taxes on your employees.
Keep your state unemployment rate low
States routinely access your tax rate based on employer experience. If you have fewer unemployment claims, your rate is normally lower.
Know the payments exempt from FUTA tax
Unemployment tax act FUTA has some tax exemptions:
Fringe benefits, group term life insurance, retirement/pension contributions (401K and SIMPLE retirement plans), and dependent care are exempt. Failing to list these items on Form 940 means you’ll pay more tax.
Fringe benefits include certain meals and lodgings, employer contributions to health plans, and other qualified expenses.
There are other payments exempt from futa tax, such as worker’s compensation payments for on-the-job injuries, payments to H-2A Visa workers, and certain types of non-employee payments.
Who is Eligible for Unemployment Insurance?
Now that you know what is FUTA, it is crucial to understand who is eligible for FUTA tax liability.
Unemployment insurance is available to individuals who lost a job through a layoff, business closeouts or are unemployed through no fault of their own. It’s possible to receive this temporary financial assistance when you meet your state’s eligibility requirements.
The Federal law establishes guidelines relating to benefit amounts and how long a person can receive unemployment insurance payments. Namely, to receive unemployment compensation, claimants must have worked for an established time.
According to the U.S. Department of Labor, most states consider that period as “the first four of the last five completed calendar quarters” before the claim.
Each state may impose other eligibility requirements, and most states pay benefits for a maximum of 26 weeks. However, claimants must meet the state’s continued eligibility requirements.
What is FUTA? A tax to help unemployed individuals
The FUTA tax definition is, in short:
FUTA taxes are an employer tax that you may owe based on the IRS guidelines noted above. If you do owe the tax, all you need to do is make deposits on time, file the annual 940 forms, and pay any additional money due.
Now that you know what is FUTA tax, you should keep learning about business finances and management.
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