Small business owners carry a lot of responsibility on their shoulders. Depending on your company, you may be in charge of hiring and training the right employees or setting the vision for your brand. Your duties might include payroll, monitoring your business credit reports, and managing your business credit scores, just to name a few. And then, of course, there’s employment taxes and payroll taxes.
The long-term success of your business depends in part on your ability to manage your taxes (or hire someone to manage them for you). Paying taxes (like federal income tax, social security tax, and Medicare tax) is an obligation you’ll need to fulfill again and again — often on a monthly, quarterly, and yearly basis.
One employment tax that you need to be aware of is known as FUTA. In this guide, we break down what FUTA means, why the tax is required, and how to calculate and pay it.
What Is FUTA Tax?
FUTA, the Federal Unemployment Tax Act, is a federal law that requires employers to pay unemployment taxes. These taxes fund the federal government’s oversight of the unemployment program in all 50 states. Typically, only employers pay FUTA taxes. You must manage FUTA taxes in two ways — deposit the tax each quarter and file an annual form.
FUTA Tax Rate 2020: How Much Are FUTA Taxes?
For 2020, the FUTA tax rate is projected to be 6%, per the IRS. The FUTA tax applies to the first $7,000 in wages you pay an employee throughout the calendar year. This $7,000 is known as the taxable wage base.
It’s worth noting that you’ll also need to pay SUTA taxes (thanks to the State Unemployment Tax Act) for your employees as well. However, FUTA and SUTA tax rates and wage base amounts may not be the same. (Check with your individual state for details about your SUTA rate and wage base requirements.)
FUTA Tax Credit
The maximum FUTA credit is 5.4%. If you’re eligible for the maximum credit, it means your remaining tax rate will only be 0.6%.
Your business will generally be able to claim the maximum 5.4% credit if it can satisfy both of the eligibility requirements below:
- Your company paid its state unemployment taxes on time (and in full).
- The state where your business files taxes is not a credit reduction state.
Credit Reduction States
Sometimes states need to borrow money from the federal government to pay unemployment benefits. Specifically, the states borrow funds from the Federal Unemployment Trust Fund.
A FUTA credit reduction state is a state that borrowed money from the trust fund but failed to repay those funds by their due date. When this happens, the Department of Labor generally steps in and names the state a credit reduction state for FUTA taxes.
If you live in a credit reduction state, you might not be eligible for the full credit against your FUTA tax rate. The result is that you could have to pay more unemployment taxes for each employee until your state repays its loan.
In November of 2019, only the Virgin Islands had past-due loan balances due to the Federal Unemployment Trust Fund. As a result, its employers were subject to a higher FUTA tax rate.
When Are FUTA Taxes Due?
It’s important to understand that, in most states, you don’t collect or withhold the FUTA tax from your employees like income tax withholding. Instead, FUTA tax is something that your business is responsible for paying as an employer.
You must pay FUTA taxes for your employees four times per year. The chart below shows when your FUTA taxes are due.
- Quarter 1 (January 1–March 31): Payment is due by April 30
- Quarter 2 (April 1–June 30): Payment is due by July 31
- Quarter 3 (July 1–September 30): Payment is due by October 31
- Quarter 4 (October 1–December 31): Payment is due by January 31
The calendar quarter dates on the left represent the pay period during which your employee received wages. The due dates on the right show when you need to deposit FUTA taxes, along with any income tax withheld for employees, with the federal government.
How to Report FUTA Taxes
Does your business have employees? If so, you may need to file an annual Federal Unemployment Tax Act report. To report your FUTA tax, you need to download and fill out IRS Form 940. For the 2019 tax year, you should file your Form 940 no later than January 31, 2020.
Who Needs to File a 940 Form?
Per the IRS, the majority of employers must pay federal (FUTA) and state unemployment taxes. Yet some businesses are exempt from FUTA (at least for certain employees). You can determine whether you’re required to pay FUTA tax using three tests — the general test, the household employee test, and the farmworkers test.
If you want to learn more about the household employees and farmworkers tests, check out Chapter 14 of the IRS Employer’s Tax Guide. Below are some highlights pertaining to the general FUTA test.
You must file a Form 940 and pay FUTA tax (on non-household employees or farmworkers) if your business satisfies any of the following criteria:
- You paid $1,500 or more in wages to employees in the last two calendar years, OR
- You had at least one employee for any 20+ weeks in the last two calendar years. Note:
- The 20 weeks don’t have to be consecutive.
- Employees who worked any part of a day count.
- Temporary, part-time, and full-time employees count.
- Self-employed individuals aren’t typically subject to FUTA.
- Partners don’t count if your business is a legal partnership that files IRS Form 1065.
- Shareholders and corporate officers in S corporations, aka businesses that file IRS Form 2553, may be subject to FUTA.
How to Calculate FUTA
Let’s assume you do owe the FUTA tax (6%) and, like many businesses, you’re eligible for the maximum credit reduction of 5.4%. Your FUTA tax liability after the credit will be 0.6% of the first $7,000 each employee earns.
Here’s a breakdown of how to calculate your quarterly FUTA liability in this scenario:
- Add up the wages paid during the reporting period to your employees who are subject to FUTA tax.
- $7,000 (John) + $2,000 (Paul) + $4,000 (George) = $13,000 Wages Earned Q1
- Multiply the quarterly wages of your employees who are subject to FUTA tax by 0.006. (This figure assumes you’re eligible for the maximum credit of 5.4%.
- $13,000 X 0.006 = $78 FUTA Liability for Q1
The IRS allows you to carry over your FUTA payment to the next quarter if your FUTA tax is $500 or less. So, in the example above, you wouldn’t need to make a FUTA deposit yet.
Final Word: FUTA Taxes 2020
As a small business owner, there are likely parts of your work that you love and certain obligations you’d rather avoid. Yet love them or hate them, employment taxes and payroll taxes aren’t something you can afford to ignore.
It’s not complicated to calculate FUTA taxes. Yet if you feel overwhelmed or too busy to manage state and federal employment taxes on your own, you can always hire a professional accountant or bookkeeper to help. Although there’s a cost associated with these services, you could pay a much higher price if you don’t handle your taxes the right way.