FUTA

FUTA stands for the Federal Unemployment Tax Act. It’s a federal law requiring that employers pay a tax to the federal government to support unemployment compensation programs. FUTA works alongside state unemployment tax systems, often called SUTA. Many employers pay both federal and state unemployment taxes, but the rules depend on the types of workers, wages paid, state requirements, and whether any exemptions apply.

The FUTA tax is different from federal income tax and payroll taxes, although they’re all employment taxes. Federal income tax is withheld from employees’ wages and sent to the Internal Revenue Service (IRS). Payroll taxes (like Social Security and Medicare) are shared between employers and employees. FUTA tax is separate from both of these and doesn’t come out of employees’ checks—it’s an extra cost that employers pay.

How FUTA works

The current FUTA tax rate is 6% on the first $7,000 of each employee’s wages per calendar year, which is known as the wage base. This results in a maximum federal tax of $420 per employee annually.

Most employers qualify for a credit of up to 5.4% when they pay state unemployment taxes on time and in full. This reduces the effective FUTA rate to 0.6%, or $42 per employee per year, for most employers.

Employers must deposit FUTA taxes quarterly when the cumulative liability exceeds $500. Annual reconciliation is reported on IRS Form 940.

Key characteristics

FUTA has specific structural features that distinguish it from other payroll taxes. These characteristics define who owes it, on what amount, and under what conditions the credit applies.

• Employer-only tax: Unlike the Federal Insurance Contributions Act (FICA), only the employer pays FUTA. It is not deducted from an employee’s paycheck. 
• Wage-based cap: The tax applies only to the first $7,000 of each employee’s annual wages.
• SUTA credit: Timely payment of state unemployment taxes qualifies most employers for the 5.4% federal credit.
• Exemptions exist: FUTA generally applies to wages paid to employees, not independent contractors. Special tests apply to household employees and farmworkers.

FUTA vs. SUTA

FUTA is the federal unemployment tax, while SUTA stands for State Unemployment Tax Act, also called state unemployment insurance (SUI). All states have their own state unemployment insurance agencies that businesses must pay on top of the federal tax. However, FUTA allows a credit for paying SUTA on time, which lowers an employer’s federal tax bill.

Considerations and best practices

FUTA compliance involves more than paying the right rate.

• Classify workers carefully. Independent contractors are not subject to FUTA. Misclassification can create significant back-tax liability.
• Track the wage base. FUTA liability is front-loaded because the tax applies only until each employee reaches the $7,000 federal wage base for the year.
• Monitor the credit reduction state status. Employers should check credit reduction status before filing Form 940 because a reduced credit can increase year-end FUTA liability.
• Deposit on time. Penalties start at 2% for deposits one to five days late and can reach 15% for amounts unpaid after an IRS notice.

Related terms

These related terms can help explain how FUTA connects to payroll taxes, employee classification, and unemployment tax reporting:

• Payroll tax: Payroll taxes are taxes tied to employee wages, payroll reporting, and employer tax obligations.
• Form 940: Form 940 is the IRS form employers use to report annual FUTA tax.
• Employee classification: Employee classification determines whether a worker is treated as an employee or independent contractor for tax and employment purposes.
• W-2 employee: A W-2 employee is a worker whose wages are reported by an employer on Form W-2.

FAQs about FUTA

Does FUTA apply to part-time or seasonal employees?

It can. FUTA generally applies to wages paid to covered employees, including full-time, part-time, and temporary employees, up to the annual FUTA wage base. Special rules and tests apply to household employees, farmworkers, certain exempt organizations, and some other worker categories.

Can a sole proprietor or single-member LLC be subject to FUTA?

Yes. A sole proprietor or single-member LLC may owe FUTA if the business pays wages to employees and meets the applicable IRS test. Under the general test, an employer is subject to FUTA if it paid $1,500 or more in wages in any calendar quarter, or had one or more employees for at least part of a day in 20 or more different weeks during the year. The owner’s own self-employment income is not employee wages for FUTA purposes.

What’s the difference between FICA and FUTA?

FICA stands for the Federal Insurance Contributions Act and covers Social Security and Medicare taxes. Both employers and employees contribute to FICA, also known as payroll taxes. The Federal Unemployment Tax Act (FUTA), on the other hand, funds unemployment benefits and is only paid by employers.