The Federal Unemployment Tax Act (FUTA) of 1939, commonly referred to as FUTA, imposes payroll taxes on most businesses that employ workers. The funds collected from this tax are utilized to assist states in administering their respective unemployment insurance programs. The standard FUTA tax rate is set at 6.0%. However, employers are eligible for a substantial reduction of 5.4% if they have paid their state unemployment taxes in full and on time for the preceding calendar year. This effectively reduces the FUTA tax rate to 0.6%. The tax is applied to the first $7,000 of each employee’s earnings, resulting in a net tax of $42 per employee, assuming the employer qualifies for the full 5.4% credit.
What to Know About FUTA Tax Increases in 2025
- Standard FUTA tax rate is 6.0%, but employers can normally benefit from a 5.4% reduction by meeting certain conditions
- States that fail to repay federal advances in time, used to shore up depleted unemployment trust funds, can experience a FUTA credit reduction, increasing the federal tax burden on employers in these states
- States may also be subject to a Benefit Cost Rate for multiple consecutive years of outstanding balances, incurring an additional credit reduction further increasing FUTA tax for employers
- Employers in California, Connecticut and New York should stay informed about potential waivers and update their tax forecasts, as these states have had outstanding balances for five consecutive years
FUTA Credit Reduction
In situations where states are unable to maintain the solvency of their unemployment trust funds, they have the option to request an advance from the federal government. Interest on these advances accrues daily over the fiscal year and is due by September 30 each year. Since these advances are essentially loans, they must be repaid by a specified deadline, with interest continuing to accrue until full repayment. If a state fails to repay the loan by the deadline and maintains an outstanding balance for two consecutive January 1sts, it will incur a FUTA credit reduction. Consequently, employers in such states will receive a reduced credit of 5.1% instead of 5.4%, thereby increasing their federal tax by 0.3%. If the state continues to have an outstanding advance for subsequent years, the credit reduction increases annually by 0.3% until the balance is fully repaid.
Additional FUTA Tax for Some States
This information is particularly relevant to employers in the states of California, Connecticut, and New York, as these states have had outstanding balances for five consecutive January 1sts. As a result, they will not only face a credit reduction but also incur a Benefit Cost Rate (BCR) and potentially a 2.7% “add-on.” Earlier this year, the United States Department of Labor (USDOL) published a document outlining the expected FUTA tax implications for employers in these states on their 2025 Federal Form 940.
The USDOL document details the impact on states with multiple consecutive years of outstanding advances. For each consecutive year beyond the first two, employers in the state face an additional 0.3% reduction in their FUTA credit. After the third consecutive January 1 with an outstanding balance, states may be subject to an additional credit reduction known as the “2.7 add-on.” After five consecutive January 1sts, states may also be subject to the Benefit Cost Rate (BCR). The USDOL document specifies the potential credit reductions for 2025, including any “add-ons” or BCR adjustments.
According to the USDOL, employers in California are estimated to face a 1.2% credit reduction and a 3.7% BCR add-on, marking the largest FUTA tax increase in the program’s history. Employers in Connecticut and New York are also expected to incur the BCR add-on, though their rates are not as high as California’s. Despite the unprecedented nature of this situation, there is a possibility for a waiver. The BCR add-on may be waived if the Governor of the affected state submits an application to the Secretary of Labor by July 1 of the year for which the waiver is requested. Additionally, the state must refrain from any actions during the 12-month period ending September 30 that would reduce solvency. As of this writing, no state has requested a waiver.
Employers in these states are encouraged to contact their Governor’s office to inquire about the waiver request. They should also update their federal tax forecasts for 2025 accordingly.
Recommendations for Employers in Affected States
In summary, the Federal Unemployment Tax Act (FUTA) of 1939 plays a crucial role in supporting state unemployment programs through payroll taxes imposed on businesses with employees. The standard tax rate is 6.0%, but employers can benefit from a 5.4% reduction if they meet certain conditions, effectively lowering the tax to 0.6%. This tax is applied to the first $7,000 of each employee’s earnings, resulting in a net tax of $42 per employee, assuming the full credit is received.
States that struggle to maintain their unemployment trust funds can request federal advances, which accrue interest and must be repaid by a specified deadline. Failure to repay these loans can result in a FUTA credit reduction, increasing the federal tax burden on employers in those states. This issue is particularly pertinent for employers in California, Connecticut, and New York, where outstanding balances have persisted for five consecutive January 1sts, leading to potential credit reductions and additional costs.
Employers in these states should stay informed about potential waivers and update their tax forecasts to account for any changes in their FUTA obligations. By understanding the intricacies of FUTA and its implications, businesses can better navigate the complexities of federal and state unemployment taxes.