Understanding federal payroll tax payments, including FUTA and SUTA

Federal and state unemployment taxes are complex. Employers must understand how governments apply and administer these taxes in order to comply with the rules and avoid tax penalties.

The Federal Unemployment Tax Act is a federal law established in 1939 to fund unemployment insurance and job programs in all states for workers who lose their jobs. The program funds the benefits from both federal (FUTA) and state (SUTA) unemployment payroll taxes. Most employers pay both federal and state unemployment taxes.

What is FUTA tax?

FUTA is a federal payroll tax payment most employers must pay. Employers are responsible for this tax, so there is no deduction from employee paychecks for it. Employers are subject to FUTA if they paid wages of $1,500 or more in any calendar quarter or had one or more employees working for at least part of a day in 20 or more different weeks of the year.

There are also FUTA obligations for certain wages paid to household employees and agricultural workers. Certain tax-exempt organizations under sections 501(c)(3) and 501(a) of the Internal Revenue Code and state and local government employee services are not subject to FUTA.

How is FUTA calculated?

Companies use IRS Form 940, Employer's Annual Federal Unemployment Tax Return to report annual FUTA tax. The general instructions explain who must file and when and where to file and pay the tax.

For 2021 and 2022, FUTA tax is calculated as 6% of the first $7,000 of wages paid to each employee during the tax year, with a maximum amount per employee per year of $42. FUTA applies to full-time, part-time, and temporary employees.

Wages subject to FUTA include salaries, commissions, bonuses, reported tips, certain fringe benefits, and certain retirement and pension amounts (certain fringe benefits and retirement and pension amounts are specifically exempted from FUTA).

Part 2 of Form 940 includes details of which employee payments to include and which ones are exempt, along with example calculations of FUTA tax.

Employers may be entitled to a maximum credit against the FUTA tax of 5.4% if they were not required to pay state unemployment tax because all taxable FUTA wages paid were excluded from state unemployment tax and if they paid all state unemployment taxes on time. This credit would reduce their effective FUTA tax rate to 0.6%.

There is a worksheet in Part 3 of the Instructions to Form 940 to use to calculate the credit reduction if some of the FUTA wages paid were subject to state unemployment tax or any state unemployment taxes were paid late.

When are FUTA taxes due?

Employers must calculate FUTA tax liability each quarter. They base the amount of tax they must pay during the year on quarterly tax amounts, and the amount of FUTA tax liability determines when they must pay the tax. If the total FUTA tax for the quarter for all employees subject to it is $500 or less, the employer does not have to deposit the tax. They can carry it over until the quarter when the cumulative amount is $500 or more and pay at the end of the first month following that quarter.

The due date for filing Form 940 each year is January 31. Employers who deposited all FUTA taxes when they were due have until February 10 to file the form, and they can file electronically or by mail.

For employers with a significant number of employees, different categories of employees, and different forms of compensation, complying with FUTA tax requirements every quarter can be complicated. If employers file returns late or pay FUTA taxes late, they could be subject to penalties and interest. Some businesses may want to consider outsourced payroll and tax filing services to help them.

What is SUTA tax?

Certain states require employers to pay additional taxes that allow the state to pay unemployment benefits. In most states, employers pay SUTA taxes, but in a few states (Alaska, New Jersey, and Pennsylvania) employers withhold SUTA from employee paychecks.

Businesses whose employees all work in one state pay SUTA taxes to that state. If employees are in multiple states, employers may need to determine which state to pay SUTA tax payments to based on unemployment tax rules and Department of Labor guidelines.

How is SUTA calculated?

Each state establishes its own SUTA tax rate and taxable wage limits for employees. Employers calculate SUTA taxes based on the employee's taxable wage amount multiplied by the state's unemployment tax rate.

Most states assign a SUTA tax rate to a business based on a range of minimum and maximum rates. The state bases rates on factors that consider the business' age and the employee turnover rate for its industry, along with its history of former employees that filed unemployment claims.

Most states use an annual reserve ratio calculation to determine the employer's experience rating, which divides the employer's account balance (taxes paid in fewer unemployment benefits paid) by its average taxable payroll for a number of years (usually up to three). Higher reserve ratios result in lower SUTA tax rates, and negative ratios result in higher rates.

Each employer must sign up for a SUTA tax account with its state(s). State agencies usually send rate notices at the end of every year that provides the tax rates for the next year and how they were determined, along with any changes to the taxable wage base. This information is also available on state government websites.

When are SUTA taxes due?

SUTA taxes are usually due at the end of the month following the last month of each quarter. They are commonly paid with employee state income tax withholdings. As discussed above, paying SUTA taxes on time can provide a FUTA tax credit of up to 5.4%. Failure to pay SUTA taxes when due can result in fines, penalties, and even criminal charges.