The Federal Unemployment Tax Act (FUTA) is a federal law requiring employers to pay a tax on employee wages to help fund the state unemployment programs that award unemployment benefits to eligible individuals. FUTA tax is paid only by employers, which means individual taxpayers are not responsible for paying. The FUTA tax rate is 6.0% and applies to the first $7,000 paid to each employee as wages during a calendar year. The $7,000 amount is called the taxable wage base and may differ from a state unemployment taxable wage base amount.
FUTA Tax Credit and FUTA Credit Reductions
Generally speaking, if an employer pays all state unemployment taxes timely and in full, they will receive a credit up to 5.4% of FUTA taxes. If an employer is entitled to the 5.4% credit, the tax rate after the credit is 0.6%. For example, if an employee is paid $10,000 in wages, the first $7,000 would be taxed at 6%, which would be a liability of $420. If taxes were paid in full and on time, the employer would receive a credit of 5.4% so the resulting liability would be only $42. Federal taxes are due by January 31 each year and are paid via the Federal Form 940.
State Unemployment Trust Fund
State unemployment benefits are paid from a state’s unemployment trust fund to individuals who are statutorily eligible to receive them. For the most part, taxes are paid into the state trust fund accounts by employers and are based on assigned tax rates multiplied by the state’s taxable wage base. If a state’s trust fund balance is in peril of becoming insolvent, the Governor may request an advance authorization via Title XII of the Social Security Act, which is basically a loan, to help the trust fund remain solvent and continue to pay unemployment benefits to eligible individuals.
As with any loan, it must be repaid within a certain period. If a state has an outstanding balance for two consecutive January 1sts, it is in jeopardy of being assessed a credit reduction on the Federal Form 940 if the amount is not paid in full by the November deadline. As mentioned previously, the full FUTA credit is 5.4%. If a state fails to repay its Title XII loan, the 5.4% credit would be reduced by 0.3% for the first year and again for each subsequent year until the balance is repaid. Using the previous example, an employer that has business in a state with a credit reduction on the Federal Form 940, would pay FUTA tax at 0.9% rather than 0.6% so the liability would increase to $63 thereby reducing the credit. If the same employer has hundreds or thousands of employees, this could become a substantial tax increase.
States with an Outstanding Balance
The 2024 Federal Form 940, Schedule A, will include a list of states and or territories with a credit reduction, consisting of California, New York and the Virgin Islands. According to the website www.fiscaldata.treasury.gov, as of November 15, 2024, California had an outstanding balance of $20,519,558,389.06, New York had an outstanding balance of $5,976,048,901.30 and the Virgin Islands had an outstanding balance of $79,963,562.64. At this time, I am unaware if or when these states/territories will pay in full, their outstanding balances. However, due to their size, it would seem it may take several years.
Since FUTA tax is levied on most employers each year, it is worthwhile to be aware of any changes that may impact the bottom line. FUTA credit reductions could have an impact on an employer’s tax risk for future years so being aware of the affected states will enable them to provide a sound forecast to their leadership teams and investors.