FUTA Calculation | consulting

How the Federal Unemployment Tax Is Calculated

Passed by the U.S. Congress in 1939, the Federal Unemployment Tax Act (FUTA) established a joint state-federal program for providing partial wage replacement payments to workers who involuntarily lose their jobs. The Act actually established the framework for the program that had originally been proposed as part of the Social Security Act of 1935.

Under FUTA employers are required to contribute to the federal unemployment insurance fund as well as the state unemployment fund for each qualifying employee. Each state administers its own unemployment program that sets the state tax rate, the taxable wage base, qualifications for receiving benefits, and the amount of such benefits.

What Is the Purpose of the Federal Unemployment Fund?

Federal funds are used to pay each state’s administrative costs. In addition, Congress may extend benefits beyond the normal 26 weeks by funding 50% of an individual’s benefits, and in times of recession the federal government can extend benefits for an even longer time by covering all of the extended benefits.

During a recession a state may have a very high rate of unemployment that may cause the state’s unemployment fund to become insolvent. Under the Reed Act of 1954 a state may borrow from federal funds when its unemployment fund drops to a certain level.

How Much Is the Federal Unemployment Tax Rate?

The current federal unemployment tax rate was established by Congress in 1983. At that time the amount of wages subject to the tax was set at $7,000 and the tax rate set at 6%. In addition, in 1976 Congress added a temporary 0.2 percent surtax. The surtax has been extended a number of times, and the last extension expired June 30, 2011.

However, most employers do not pay the 6.0% FUTA tax rate. The FUTA tax rate may be reduced based on credits for payments made to the employer’s state unemployment tax fund.

There are two types of credits that can reduce an employer's FUTA liability:

The "normal" credit, which is equal to 90% of the FUTA tax rate. 90% of 6.0% equals 5.4%. When the normal credit is applied, the effective tax rate drops to 0.6%. (6.0% - 5.4% = 0.6%) The normal credit can only be taken by an employer on the percentage of state unemployment (SUTA) taxes that have been paid before the due date of Form 940. So if an employer has only paid 80% of its SUTA liability on time, it can only take the normal credit on 80% of its FUTA liability.
The "additional" credit is a credit equal to the difference between the employer's SUTA tax rate and 5.4% if the employer's SUTA tax rate is less than 5.4%. The additional credit can be taken even if the employer's entire SUTA liability has not been paid.

The total credits taken cannot be more than 5.4%, so all employers will pay FUTA tax of at least 0.6% of its taxable FUTA wages. This is known is as the normal effective tax rate.

An employer’s FUTA credits will be reduced if it has not paid all of its SUTA taxes on time, but the credits may also be reduced if the state in which the employer pays SUTA taxes is a credit reduction state. If any state unemployment agency borrows funds from the federal unemployment trust fund and fails to repay the loan within 2 years, the state credit is reduced by 0.3 percent for each year the loan is past due.

How Is the Federal Unemployment Tax Reported and Paid?

Every employer that has wages subject to the FUTA tax must file Form 940 before January 31st of the following calendar year (or the first business day of February if the 31st is on a weekend). According to the Instructions for Form 940, an employer must calculate its FUTA liability at least quarterly.

If an employer’s FUTA tax liability is $500 or more for a year, the employer must make at least one quarterly tax deposit during the year. (Note: As of January 1, 2011, all federal tax deposits must be made electronically.) Any calendar quarter in which an employer’s unpaid liability exceeds $500, the estimated liability must be deposited by the last day of the month following the end of the calendar quarter.

For instance, an employer in South Carolina has paid $44,200 in wages subject to the FUTA tax in the first quarter of 2011. Since South Carolina was a credit reduction state in 2011, the effective tax rate is 0.9% (0.6% + 0.3%). Therefore, the employer’s first quarter FUTA liability is $397.80 ($44,200 x .009). Since the liability is less than $500, it does not have to be deposited.

However, in the second quarter the employer calculates an additional $156.20 in FUTA liability. Since the total liability exceeded $500 during the second quarter, the enter liability of $554.00 must be deposited before August 1, 2011, since July 31 is a Sunday.

Completing Form 940

The above article discusses the legal basis of the Federal Unemployment Tax and the factors that affect how the tax is calculated. The following article will discuss how the tax is reported and calculated on Form 940.