What it means
When a worker loses a job through no fault of their own, they can claim unemployment benefits. Most of the money for those benefits comes from state unemployment taxes on employers, while FUTA pays for the federal side of the system, including administration and part of the extended benefits.
Employees do not pay FUTA, and employers cannot deduct it from wages. The tax works on a wage base, which is the maximum amount of each employee's yearly pay that is taxed.
The law sets a gross rate, a wage base and a maximum credit for state tax paid. For many years the figures have been a gross rate of 6.0% on the first $7,000 of each employee's wages, with a credit of up to 5.4%, leaving an effective rate of 0.6%.
To receive the full credit, the employer must pay its state unemployment tax in full and on time, and the state must meet federal requirements. If an employer pays late, the credit is cut and the effective rate rises.
In addition, if a state has borrowed from the federal government to pay benefits and has not repaid the loan, employers in that state may face a credit reduction, which increases the FUTA bill. Employers calculate the tax each quarter and deposit it when the accumulated liability passes a set threshold, then file an annual return.
The cost is small per employee, which is why it is often overlooked in budgets, but it is a legal obligation with penalties for non-payment. Payroll software normally handles it automatically.
A key nuance is that the wage base is low, so the tax is front-loaded: once an employee has earned the first $7,000 in a year, no more FUTA is due on that person. Firms with high turnover, or with many seasonal workers, therefore pay more per head than firms with stable staff, because each new hire starts a new wage base.
In practice
Real-world examples.
Example
A landscaping company hires 30 seasonal workers, each earning at least $7,000 over the summer. It pays state unemployment tax on time, so the effective federal rate is 0.6%. The FUTA bill is 30 x 42 = $1,260, and the owner includes it in the payroll cost per worker.
Example
A restaurant with high staff turnover employs 60 different people in a year, though only 25 positions are filled at any one time. Because every person reaches the $7,000 base, the restaurant pays FUTA on 60 people, not 25. The finance manager sees the cost of turnover rising by 60 x 42 = $2,520 in total.
Example
A consulting firm pays its state tax three months late. It loses part of the credit, so its effective federal rate rises above 0.6% for the affected wages. The firm's accountant adds a payment reminder to the monthly close checklist.
Formula
Calculation
FUTA tax = Number of employees x Wage base x (Gross rate - Credit)
The figures below use the long-standing rates of 6.0%, a 5.4% maximum credit and a $7,000 wage base. A firm has 20 employees, and each earns more than $7,000 in the year. The effective rate is 6.0% - 5.4% = 0.6%, so the tax per employee is 7,000 x 0.006 = $42. For 20 employees the total is 20 x 42 = $840.Case study
Seen in the real world.
Greenfield Hospitality is an illustrative, fictional hotel group with 140 employees, all earning above the wage base. The new payroll manager was asked to explain why the FUTA line was small but still needed careful attention.
She calculated the annual cost as 140 x 42 = $5,880, then showed that a late state payment on a quarter of the wages would have raised the bill by several thousand dollars. She also pointed out that the hotel's state was repaying a federal loan, so a small credit reduction might apply.
The hotel set up a calendar for state and federal deposits and began budgeting the credit reduction as a contingency. The illustrative lesson is that a small percentage tax can still cause costly penalties when deadlines are missed.
Watch out
Common mistakes.
- Deducting FUTA from employees' wages, when it is a tax paid only by the employer.
- Paying state unemployment tax late, which reduces the credit and increases the federal bill.
- Ignoring FUTA for part-time or seasonal workers, even though each one starts a new wage base.
Questions
People also ask.
Who pays FUTA?
Only the employer pays it, and it is calculated on the first slice of each employee's yearly wages.
Why is the effective rate so much lower than the stated rate?
Because employers receive a credit for state unemployment tax paid on time, which reduces the gross rate to a small net figure.
How often is FUTA reported?
It is reported annually, although deposits may be required during the year if the amount owed passes a set threshold.
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