It’s been a running joke for years that employees often look at their pay stubs and wonder, “What the heck is FUTA?” If your organization has been up and running for a while, you’re no doubt familiar with this payroll tax obligation — so familiar that you may not expend much thought on what it is or why it exists.
But whether in the context of explaining FUTA to curious staff members or managing your organization’s liability, it’s important to keep certain fundamental facts in mind.
Funding mechanism
First things first, FUTA stands for the Federal Unemployment Tax Act. Under this law, the FUTA tax was created to fund a program that helps individual states pay unemployment benefits for eligible individuals who have been terminated from their jobs without “just cause” — but not those who have voluntarily quit.
On the federal level, the program funds benefits to employees who have been terminated or laid off through no fault of their own, including because of illness or disability. Currently, benefits may be paid out for up to 26 weeks or until former employees find new jobs or become self-sufficient. Traditionally, extensions have been allowed under special circumstances, such as during the pandemic.
Employers that pay wages of $1,500 or more in any calendar quarter of the preceding or current tax year must pay FUTA annually. While FUTA is administered and collected by the IRS, state unemployment tax is a separate obligation paid to the applicable state authority.
Each state operates under its own unemployment tax laws to determine the amounts that should go toward state unemployment insurance. Eligibility for unemployment benefits also generally differs by state. Thus, along with managing their FUTA obligations, employers need to keep tabs on their respective state unemployment tax rules.
Claiming the credit
FUTA tax rates and thresholds have remained the same for decades. In 2024, FUTA is applied at a 6% rate to the first $7,000 of wages an employee earns. Therefore, the maximum tax is $420 per employee (6% of $7,000). If, for example, an organization employs 50 workers, the FUTA tax would max out at $21,000 (50 × $420).
However, perhaps the most important FUTA fundamental of all is most employers qualify for a credit of up to 5.4% — so long as they pay into their state unemployment insurance fund. In other words, the effective tax rate for employers in most states is only 0.6%. This can make a substantial difference in the amount of FUTA owed.
Returning to the previous example, if an employer has 50 employees earning $7,000 or more for the year, the beginning FUTA tax liability is $21,000. But assuming the 5.4% credit is available, the employer’s rate is reduced to 0.6% or $42 per worker. In this case, the employer’s total FUTA liability is only $2,100 (50 × $42), or $18,900 less ($21,000 – $2,100) than it would owe without the credit.
Note: States are allowed to take federal Unemployment Trust Fund loans from the federal government if they lack funds to pay unemployment benefits. If your state fails to repay a federal unemployment loan within two years, your organization’s credit is reduced by 0.3% each year until the state’s loan is repaid. Therefore, employers in “credit reduction” states must pay more FUTA. According to the U.S. Department of Labor, as of January 1, 2024, California, Connecticut and New York were subject to credit reduction.
Addressing your challenges
Once you’ve explained FUTA to an employee, a common follow-up question is, “OK, now what’s FICA?” But that’s a subject for another article. We can help you develop strategies to address your organization’s distinctive payroll tax challenges.
© 2024