If you’re a business owner, you know one of your main responsibilities is ensuring you’re remaining compliant with the IRS. This means paying all taxes on time and in full. One of the most common payroll taxes most employers are responsible for paying is their federal unemployment tax. In short, the federal unemployment tax is used to help administer the state unemployment insurance programs which pay for unemployment benefits given to workers who have lost their jobs.
However, as a business owner, the state of the economy can greatly impact your business, and the unemployment rate can often be a key indicator of how well the economy is performing, meaning you might be wondering how exactly the unemployment rate can affect business. So, how does the unemployment rate affect business? In this guide, we’ll walk you through federal unemployment taxes, the differences between federal and state unemployment taxes, the unemployment rate’s effect on business and more.
Summary
- The Federal Unemployment Tax Act (FUTA), established by President Franklin D. Roosevelt in 1939, is a federal tax funding unemployment benefits for laid-off workers.
- Only employers are required to pay FUTA taxes. These taxes are only paid by employers who pay wages of $1,500 or more to employees or employers with at least one full-time, part-time or temporary employee and who works for some portion of the day or at least 20 weeks in the year.
- The federal unemployment tax rate is 6 percent, and applies only to the first $7,000 of wages for each employee. However, employers might be eligible for a tax credit of up to 5.4 percent if they make on-time payments to their state’s unemployment program.
- FUTA taxes differ from SUTA taxes in that SUTA taxes are used to fund state unemployment programs. On the other hand, FICA taxes, established by the Federal Insurance Contributions Act (FICA), are withheld from each employee’s wages to fund Social Security and Medicare.
- Economic fluctuations can impact your FUTA liability, as ebbs and flows in the economy can cause ebbs and flows in employment. For example, employers might be required to pay higher unemployment insurance premiums during periods of high unemployment.
- Employers can manage unemployment during economic downturns with the help of unemployment services like Experian Employer Services.
What Is FUTA?
Passed in 1939 as a part of President Franklin D. Roosevelt’s New Deal legislation, the Federal Unemployment Tax Act (FUTA) was created to help workers during the Great Depression who had lost their jobs. Today, the Federal Unemployment Tax Act is a piece of legislation that still requires businesses to pay a payroll tax to help fund unemployment benefits for workers who have lost their jobs or have been terminated—except for workers who have been terminated for gross misconduct. This act provides partial wage replacement to help workers afford basic necessities while continuing to search for employment.
Who Pays FUTA and When?
Now that you know what the federal unemployment tax is that was established by the Federal Unemployment Tax Act, who pays FUTA and when? Federal unemployment taxes are only paid by the employer, not the employee, which means these taxes will not be deducted from an employee’s paycheck. Additionally, there are two conditions under which an employer might be subject to paying FUTA taxes, including:
- Employers who pay wages of $1,500 or more to employees are required to pay unemployment taxes to the federal government.
- Employers with at least one full-time, part-time or temporary employee on their payroll and who works for some part of the day or at least 20 weeks in the year are responsible for paying FUTA taxes.
This means that self-employed individuals are not responsible for paying FUTA taxes, as well as those who hire independent contract workers for their business. It’s also important to note that federal unemployment taxes are paid in addition to any state unemployment taxes.
The tax rate for federal unemployment tax is 6%, which is only applied to the first $7,000 of wages for each employee. However, many businesses qualify for a tax credit of up to 5.4% if they pay timely into their state’s unemployment program and have timely filed all necessary returns, bringing their FUTA tax rate down to 0.6%. Depending on the company, federal unemployment tax can be paid quarterly or annually.
For example, let’s say in Q1 Employee A earns $15,000 and Employee B earns $4,000, both subject to FUTA taxes. For Employee A, only the first $7,000 would be subject to FUTA taxes. Here’s how to calculate how much you owe:
- (Employee A’s Eligible Wages + Employee B’s Eligible Wages) x 6% = FUTA tax liability
- ($7,000 + $4,000) x 0.06 = $660
In this example, the employer would owe $660 in FUTA taxes for Q1 for their two employees. However, if the company is eligible for the 5.4% tax credit for paying into its state unemployment program, it would owe $66 in FUTA taxes. Here’s how:
- (Employee A’s Eligible Wages + Employee B’s Eligible Wages) x 5.4% = FUTA tax credit
- ($7,000 + $4,000) x 0.54 = $594
With a FUTA tax liability of $660 and a tax credit of $594, the employer would owe $66 in FUTA taxes for Q1.
FUTA vs. SUTA
Federal unemployment taxes aren’t the only payroll taxes for which employers are responsible. As previously mentioned, employers are also subject to their state’s unemployment program, which provides unemployment benefits to residents of that state. State Unemployment Taxes, or SUTA, can range anywhere between 2% and 5% of an employee’s wages, depending on the state. Employers can claim a tax credit of up to 5.4% to lessen the burden of federal unemployment taxes.
FUTA vs. FICA
Along with federal unemployment taxes, employers are responsible for paying FICA taxes. The Federal Insurance Contributions Act (FICA) requires employers to withhold a portion of an employee’s wages to help fund Social Security and Medicare, which are two separate federal welfare programs.
FICA taxes total 15.3% of an employee’s earnings, and this percentage is split equally by the employer and employee, meaning both parties pay 7.65%. However, a portion goes toward Social Security while another goes toward Medicare. As the employer, you are responsible for paying 6.2% toward Social Security and 1.45% toward Medicare, while the employee also pays a 6.2% Social Security tax and 1.45% Medicare tax.
Because FICA taxes are a payroll tax, they will be seen on an employee’s paycheck. Below are the tax limits and rates for 2022 and 2023:
- 2022 Social Security Taxes: 6.2% on the first $147,000 for employers and 6.2% on the first $147,000 for employees.
- 2023 Social Security Taxes: 6.2% on the first $160,200 for employers and 6.2% on the first $160,200 for employees.
- 2022 Medicare Taxes: 1.45% for both employees and employers, with the employee paying an additional Medicare tax of 0.9% on wages over $200,000 for single filers and $250,000 for joint filers.
- 2023 Medicare Taxes: 1.45% for both employees and employers, with the employee paying an additional Medicare tax of 0.9% on wages over $200,000 for single filers and $250,000 for joint filers.
FUTA in 2023: Will My Tax Contribution Increase?
Inflation, unemployment and business cycles may contribute to unemployment rate increases during business recessions because states have to pay for the increased number of their residents receiving unemployment benefits. You might be wondering if your tax liability will increase in 2023 with the current state of the economy and the ongoing coronavirus pandemic. The answer is, it depends.
Employers might be eligible for a 5.4% tax reduction if they file their state unemployment taxes by their state’s respective deadline and in the full amount. However, this tax credit can be affected by the FUTA credit reduction.
In some cases, states may obtain an advance from the federal government through a Title XII loan. However, sometimes, a state might not repay the loan by the prescribed period. Under Section 1201 of the Social Security Act, states are allowed to request an advance from the Federal Unemployment Fund to help replenish their unemployment trust fund balances. Part of the agreement of the advance is to repay these funds by a specified time. For 2022, that deadline was Sept. 30. After this date, interest starts accruing.
Additionally, for states that requested an advance on Jan. 1 of two or more consecutive years and did not repay the advance by Nov. 10 of the second year, the FUTA credit reduction will be enforced, which will require states to pay 0.3% of federal taxable wages for the first year, and an additional 0.3% of federal taxable wages for subsequent years until the total amount of the debt is repaid.
As of January 2023, several states are subject to the FUTA credit reduction, including California, Connecticut, Illinois and New York. In most cases, the COVID-19 pandemic wiped away the unemployment funds of these states, requiring them to borrow from the Federal Unemployment Fund. With the ongoing economic instability, many of these states are having difficulty repaying their advance on time.
So, what does that mean for businesses operating in these states? It means businesses should be aware of the additional tax cost that can come with states having to repay these loans. If you’re operating in one of these states, adding these estimates to your forecast can help you budget appropriately to ensure your finances are strong.
Managing Large Fluctuations in Employment
The economy ebbs and flows, with periods of economic growth and periods of recession. With these economic changes come fluctuations in employment, which can be a challenge for companies that aren’t prepared to weather periods of economic growth or decline.
How does a low unemployment rate affect businesses compared to a high unemployment rate? While a low unemployment rate can be a sign of a strong economy with many workers, it can also carry a few potential downsides, such as increased wage inflation and reduced productivity. For example, in an economy with low unemployment rates, the labor market can experience reduced productivity because new jobs added to the market aren’t worth paying, as salaries, benefits and equipment aren’t worth the cost.
However, high unemployment rates can also pose plenty of downsides. A high unemployment rate’s effect on business can be detrimental. With more people out of work, there’s less incentive to spend, which can slow the economy’s recovery. Because fewer people are spending money, businesses might notice a decrease in sales, revenue and profits. This can continue into a cycle of businesses reducing their workforce, further raising the unemployment rate, which then reduces consumer spending.
To combat this, the federal government will often intervene through fiscal policy, such as increasing taxes, reducing the federal funds rate and purchasing U.S. Treasury and mortgage-backed securities on the open market. These are some of the ways the federal government will attempt to add money into the economy to encourage businesses to increase production, which, in turn, requires more workers.
As a business, it’s important to know how to manage fluctuations in employment, whether it’s bringing on a larger team during periods of increased productivity or making the difficult decision to reduce your workforce. Working with a workforce management service like Experian Employer Services can help you with everything from tax services to unemployment management.
Let Your Tax Management Service Know in Advance
Employers must often make difficult choices during economic downturns, including the possibility of letting loyal team members go. If you find yourself in this situation, there are things you can take to ensure you are doing everything possible to help your staff get through these challenging times.
As a third-party administrator, Experian Employer Services maintains a broker account with the State Information Data Exchange System (SIDES), where we electronically receive and reply to claims to speed up the processing of unemployment claims submitted by displaced workers. By providing us with a simple data file with all the information we need up front, you can make it easy for our team to reply to claims right away with all the facts the State Unemployment Agency needs to make an expedient assessment. By responding to the first claim for benefits right away and including all pertinent information about the layoff, including any separation type pay, your impacted employees won’t experience any delays in receiving unemployment benefits.
At Experian Employer Services, we know it can be hard to make these difficult choices during trying times, as you want to do everything you can to support your employees. We invite you to get in touch with our service and delivery team if you foresee any such situation so that we can discuss what can be done beforehand to hasten unemployment payouts while also lessening the administrative strain and any associated costs. We employ a staff of experts who can help you through the process in addition to our quick automatic response system. With our payroll tax services by your side, unemployment management has never been easier.
FAQs
How do I file my FUTA tax return?
For employers looking to file a FUTA tax return, use IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.
What happens if I miss the deadline for filing my FUTA tax return?
For those who miss the deadline, a 10 percent penalty can be issued, and additional consequences could be imposed, such as interest on back taxes, property liens and more.