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Betsy Wise
By: betsy_wise
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What Is FUTA? Understanding the Federal Unemployment Tax Act

Among the numerous responsibilities a business owner has, paying taxes is an important one. They must know which employer taxes they’re required to pay, when the taxes are due, and ensure that tax payments are submitted on time. In some businesses, a bookkeeper keeps up with FUTA, FICA, estimated, and other taxes paid quarterly and annually. But, what is FUTA?

This post will explain what is FUTA tax, its benefits, which businesses pay unemployment insurance taxes, how to file FUTA taxes, and tips to reduce the tax your business owes.

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What is FUTA?

The Federal government uses money collected from businesses through the Federal Unemployment Tax Act to provide unemployment compensation to individuals who are out of work. Only employers pay the tax on behalf of their employees as FUTA tax is not deducted from employees’ wages.

Is FUTA the same as Social Security?

No, it’s not. Employers report and pay FUTA tax separately from Federal Income tax, and Social Security and Medicare taxes 

Who Pays FUTA Tax?

As stated above, the first thing you should know is that employees do not pay FUTA taxes, only employers do. 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.

The maximum wage base for computing FUTA tax is the first $7,000 of each employee’s gross pay. When an employee’s gross pay exceeds $7,000, no FUTA tax is assessed on the excess over $7,000.

Who is Exempt from Paying FUTA Tax?

Most businesses are required to pay FUTA tax. However, government employers and nonprofit religious, charitable, and educational institutions, are exempt from paying FUTA tax.

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.

  1. Employees are not household or agricultural employees.
  2. You paid $1,500 in wages to employees in at least one calendar quarter per year.
  3. You paid employees (full time, part-time, and temporary) that worked some part of a day in at least 20 or more different weeks.

How Much is the FUTA Tax?

When learning what is FUTA, you need to know that its tax rate is calculated on the first $7,000 paid to each employee.

What is the FUTA tax rate for 2020?

The FUTA tax rate for 2020 is 6% on the first $7,000 in wages that any employer paid 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 be able to claim a credit for up to 5.4% of taxable FUTA wages. 

When states lack funds to pay unemployment compensation, they can borrow money from the Federal government which is taken out of their Federal Unemployment Tax Act funds.

States that are unable to repay the loan are considered credit reduction states. Employers in those states are given a reduced FUTA tax rate.

Therefore, the total amount you owe on taxable wages can be adjusted based on exclusions and credit reductions which can vary per state.

How and When Do You File FUTA Tax Payments?

Knowing what is FUTA also means knowing that these tax deposits are made quarterly. The IRS charges penalties and interest when you fail to make payments on time. 

Quarterly Taxes vs Annual Taxes: Which Ones Do You Have to Pay?

Any time your 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. 

Each deposit is due the last day of the month after each quarter ends. For example, the first quarter ends in March so the deposit must be made by the last day in April. 

When you apply for an EIN to register your business, the IRS automatically pre-enrolls you in their EFTPS (electronic federal tax payment system). If you don’t have an account, you can contact the IRS at EFTPS.gov. 

In addition to making quarterly FUTA tax deposits, you must file Form 940. It’s 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.

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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 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 which payments are exempt from FUTA tax

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. 

Other payments may be exempt 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?

When answering the question “What is FUTA?” it is important to know who is eligible for this insurance. 

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.

Guidelines are established by Federal law 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, the majority of states consider that period as “the first four of the last five completed calendar quarters” prior to when a file is claimed. 

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.

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What is FUTA? A tax to help unemployed individuals

So, what is FUTA? It’s 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 form, and pay any additional money due.

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