The unemployment rate in America is hovering around 4 percent right now - much lower than it used to be following the 2008 financial crisis.
Still, there will always be a few people on the unemployment lists. The FUTA tax is the government's way of making sure those people can get unemployment when they need it.
As a business owner, it's important that you understand this tax so you'll know how much you need to pay each year. The amount of tax you pay depends on your employees' salaries, but as with all tax issues, it can get complicated.
To simplify things for you, we've put together this essential guide to understanding the FUTA tax and how it affects your business. Read on to find out everything you need to know.
What is the FUTA Tax?
FUTA stands for Federal Unemployment Tax Act. This is the law that maintains that employers must pay an unemployment tax.
This tax is paid only by employers - it's not withheld from employee's wages. A FUTA form needs to be filed once a year, and the tax needs to be deposited quarterly.
The specifics of unemployment depend on what state you're in. However, this tax provides funding for the government to oversee the unemployment program in each state.
State unemployment taxes are separate from FUTA. In some states, these taxes are called SUTA (State Unemployment Tax Act) taxes, reemployment tax, or unemployment insurance.
Sometimes, a state may not have enough to cover unemployment benefits for everyone who's collecting them. In these cases, that state will borrow from the federal government to pay unemployment.
FUTA taxes create the pool of money that the state can borrow from. It's a sort of insurance policy to make sure that each state always has enough.
When unemployment rates are high, the FUTA money can also be used to pay half of the extended unemployment benefits that are being collected.
History of the FUTA
This tax act came out of the Great Depression. One-quarter of the workers in the U.S. were unemployed in 1932, and something needed to be done.
President Roosevelt created a Committee on Economic Security in 1934 to find a way to protect people from unemployment disasters like that in the future. Unemployment insurance was an important part of this goal.
Unemployment was a way to help lessen the burden of welfare programs, while still making sure that people who were involuntarily unemployed could get by. In 1939, the Federal Unemployment Tax Act was passed to help make this happen.
Who Has to Pay FUTA?
Any company that pays over $1,500 in employee wages per quarter has to pay this tax. Or, if your business has one or more employees on payroll for a day (or a partial day) for 20 or more weeks, you'll have to pay FUTA.
In short, this tax applies to all but the smallest businesses.
How Much Will I Pay?
The amount varies based on the year. This year's FUTA tax rate is 6 percent.
However, you'll only pay FUTA taxes on employee wages up to $7,000. Once you've paid an employee more than $7,000 for the year, you don't need to pay any more FUTA taxes on their earnings.
Using this year's tax rate, that means that you'll pay no more than $420 for each of your employees.
Are Tax Credits Available?
For most employers, there is an available tax credit for the FUTA tax that they are eligible for.
This means you can pay a lower tax rate, which can be a huge help to small businesses. The credit is for up to 5.4 percent of the tax. However, there are other credits that are available for less than the maximum amount.
To get the credit, you'll need to make sure that you always pay the state unemployment taxes on time, and pay the full amount each time. Late payments, partial payments, or being located in a credit reduction state can all prevent you from qualifying for a credit.
What is a Credit Reduction State?
As mentioned above, a state can borrow from the money the federal government has collected using FUTA. However, that loan must be paid back.
If two years pass and the state hasn't paid back that loan, that state turns into a credit reduction state. All employers in that state will then have a reduced FUTA credit.
This means that there is a lower maximum credit available for businesses in that state.
Making FUTA Tax Deposits
Each quarter, you have to calculate your FUTA tax and make a deposit.
However, if you have a FUTA tax payroll liability of $500 or under for that quarter, you won't need to make a tax deposit for that quarter. Instead, the tax liability can be rolled over to the next quarter and a deposit can be made then.
The deposit will always be made electronically. The Electronic Federal Tax Payment System is the most common way to make your FUTA deposit.
The deposit is due on the final day of the final month of that quarter.
Annual Tax Form
In addition to quarterly deposits, there is one tax form that must be filled out annually about your FUTA taxes. The form you'll be using is Form 940.
Each year, this form has to be turned in by the end of January. The form you turn in will cover your FUTA taxes for the previous year. So, for example, your form for 2017 will be due on January 31, 2018.
There are also a few wages that are exempt from FUTA taxes.
If the work happened outside the U.S., those wages are exempt. Same goes for wages paid to immediate family members, wages paid to hospital interns, wages paid to students by the school, and wages paid by a non-profit. Read more about these exemptions here.
Understanding the FUTA is an important part of being a business owner. However, it's not easy to keep up with the financial side of the business when you're also taking care of day-to-day operations.
As a small business owner, there are many things that can make payroll complicated. However, we can help. To learn how we can simplify payroll for your business, contact us today.