Federal Unemployment Tax (FUTA)

Federal unemployment tax, usually called FUTA tax after the Federal Unemployment Tax Act, is a United States payroll tax that employers pay to fund the federal part of the unemployment insurance system. Unlike Social Security and Medicare taxes, it is paid only by the employer and is never deducted from an employee's pay. The money pays for the administration of state unemployment programs, part of the cost of extended benefits during periods of high unemployment, and a federal fund from which states can borrow when their own unemployment trust funds run low.

FUTA works alongside state unemployment tax, often called SUTA or state unemployment insurance. States pay the actual weekly benefits to jobless workers out of their own funds, while FUTA supports the system's overall structure. In accounting, FUTA is one of the main employer payroll taxes and is recorded as an expense and a liability.

The gross FUTA rate is 6.0 percent, applied only to the first $7,000 of wages paid to each employee in a calendar year. Wages above $7,000 per employee are not taxed. Employers that pay their state unemployment taxes on time receive a credit of up to 5.4 percent against the federal tax, giving a net rate of 0.6 percent. In practice this means most employers pay no more than $42 of FUTA tax per employee each year:

Here $\text{Taxable wages}$ are wages paid to each employee up to the $7,000 limit, and $\text{Net FUTA rate}$ is 6.0 percent less any credit, usually 0.6 percent. If a state has borrowed from the federal fund and not repaid the loan within the allowed time, it becomes a "credit reduction state," and employers there lose part of the credit, paying a higher effective rate until the loan is repaid.

A company has three employees. In the first quarter, one is paid $15,000, one $9,000 and one $5,000. The taxable wages are $7,000, $7,000 and $5,000, which total $19,000. At the net rate of 0.6 percent, the FUTA tax is $114. The journal entry debits payroll tax expense for $114 and credits FUTA tax payable for $114. Once the first two employees reach the $7,000 cap, no further FUTA tax is due for them for the rest of the year, so FUTA expense is concentrated in the early months.

When the company deposits the tax, it debits FUTA tax payable and credits cash. The liability sits among current liabilities on the balance sheet until paid, and an unpaid amount at period end is part of accrued payroll costs.

Employers report FUTA annually on Form 940, due by 31 January of the following year. Deposits, however, are made quarterly when the accumulated liability exceeds $500; smaller amounts can be carried forward to the next quarter. Deposits are made electronically through the Electronic Federal Tax Payment System using the employer's employer identification number.

An employer generally owes FUTA if it paid $1,500 or more in wages in any calendar quarter, or had at least one employee for some part of a day in 20 or more different weeks in the current or previous year. Separate tests apply to household and agricultural employers. Some organizations are exempt, including charities described in Internal Revenue Code section 501(c)(3), although they may have state obligations.

FUTA is not a tax on the worker, so it does not appear on employees' pay stubs or W-2 forms. It applies only to employees, not to independent contractors, which is one reason worker classification matters. The tax was created in 1939, recodifying the unemployment provisions of the Social Security Act of 1935, which built the federal-state social security framework still in place today. For budgeting, employers can estimate annual FUTA cost simply by multiplying headcount, including expected turnover, by $42, adjusted for any credit reduction. Because the cost is small and front-loaded, many businesses forget to accrue it, which is a common payroll accounting error. Other taxes on payroll, including state unemployment tax, usually cost considerably more.

• Internal Revenue Service
• U.S. Department of Labor