FUTA Tax

What is FUTA?

The Federal Unemployment Tax Act (FUTA) was established in 1939 as part of the Social Security framework to help states fund unemployment benefits for workers who lose their jobs through no fault of their own, such as layoffs or business closures.  

Unlike Social Security and Medicare taxes, the FUTA tax is paid solely by employers; employees don’t share this cost. However, the tax is calculated each time payroll is processed, making it part of employer payroll obligations.

FUTA works hand in hand with the State Unemployment Tax Act (SUTA). While both laws help fund unemployment insurance programs, FUTA is managed by the Internal Revenue Service (IRS) at the federal level. Individual state governments manage SUTA taxes.  

What Does FUTA Mean for Employees and Employers?

FUTA affects employers and employees in different ways. For employers, this federal employer tax represents legal and financial responsibilities; for employees, it provides an important safety net.

Employers are required to pay FUTA tax on the wages they pay to their employees. This tax helps fund the federal portion of state unemployment insurance agencies, which in turn supports state programs. Employers must calculate and pay the tax throughout the year, typically making quarterly deposits and filing an annual Form 940 with the IRS. Specifically, if FUTA tax liability is more than $500 for the calendar year, you must deposit at least one quarterly payment.

From the employee’s perspective, FUTA can offer peace of mind. While employees don’t contribute to FUTA, they benefit from the protection it provides. When a worker becomes unemployed, the benefits they receive are partially funded through the taxes their employer has paid under this program.

How Does FUTA Tax Work?

FUTA is calculated based on the wages paid to employees and is subject to specific federal guidelines.

Employers must pay FUTA tax if they paid $1,500 or more in employee wages during any calendar quarter or had one or more employees working at least part of a day in 20 or more weeks during the year.

To calculate employer FUTA liability:

• Determine total wages paid to all employees in the previous quarter. If the total exceeds $1,500, you are required to pay FUTA tax.

• Apply the current standard FUTA tax rate, which is 6%, to the first $7,000 of each employee’s annual wages. Any wages above $7,000 per employee are not subject to FUTA.

• Account for the FUTA tax credit. Employers who also pay state unemployment taxes (SUTA) on time and in full are typically eligible for a FUTA tax credit reduction of up to 5.4% of FUTA taxable wages, making the effective FUTA tax rate 0.6%.

Here's an example to show how this might work:

Consider a business with 10 employees, each earning at least $7,000 during the year.

• The total taxable wages would be: $7,000 × 10 = $70,000.

• At a 6.0% rate, the FUTA tax liability before credits would be $4,200 ($70,000 × 0.06).

• After applying the typical 5.4% credit, the employer would owe $420 in FUTA tax.

Employers generally deposit FUTA tax payments quarterly and file Form 940 annually with the IRS. Payments are due by the last day of the month following the end of each quarter (April 30, July 31, October 31, and January 31).

When does the FUTA rate change?

The FUTA tax rate is established by federal law and can change if Congress updates unemployment funding or credits. The standard rate is currently 6%, but most employers receive a FUTA credit of up to 5.4% when state unemployment taxes are paid on time. Employers should check the IRS website or Form 940 instructions each year for any updates to the rate or credit.

Who is Exempt from FUTA?

Some employers are entirely exempt from paying FUTA tax because of the nature of their organization. These typically include:

• Federal, state, and local government agencies

• 501(c)(3) nonprofit organizations that are recognized as tax-exempt by the IRS

• Federally recognized tribal governments participating in state unemployment programs

While these entities are not required to pay FUTA tax, they may still have other payroll tax obligations.

Certain types of employment are also exempt from FUTA coverage. Examples include:

• Household employees who are paid less than $1,000 in any calendar quarter

• Agricultural workers employed by small farms (those paying less than $20,000 in cash wages per quarter or employing fewer than 10 workers in 20 different weeks during the year)

• Family employees, such as children under 21 working for a parent or a spouse working for another spouse

• Certain foreign or international organization employees

If your business or your workers qualify for any of these exemptions, you are not required to calculate or pay FUTA tax for those wages. However, it’s important to keep accurate payroll records and confirm that your organization or employee type truly meets the exemption requirements.

If you're not sure if your business, employees, or household workers qualify for an exemption, you can review IRS Publication 15 for more details or consult a qualified tax professional.

Understanding FUTA on Your Paycheck

While FUTA tax is an employer-paid expense, questions about it can sometimes come up among employees, especially if they see a reference to "FUTA" on a paystub or in payroll documentation. As a small business owner, it helps to understand how to explain this tax clearly and accurately.

Under FUTA, employers, not employees, are responsible for paying the tax. This means no portion of an employee’s paycheck should be withheld to cover FUTA. However, because payroll software and accounting systems often display all payroll-related taxes together, employees may mistakenly think FUTA is being taken out of their earnings.

If an employee asks why FUTA appears on a paystub or report, you can reassure them that it’s an employer-only tax. The funds come from your business, not from their wages, and they help support unemployment benefits if a worker loses their job through no fault of their own.

FUTA vs FICA

Both FUTA and FICA are federal payroll taxes, but they serve very different purposes and are funded in different ways.  

FUTA is:

• Paid entirely by employers.

• Funds unemployment insurance programs that provide temporary income to eligible workers who lose their jobs.

• Calculated on the first $7,000 of each employee’s annual wages.

FICA (Federal Insurance Contributions Act) tax is:

• Paid by both employers and employees through payroll deductions.

• Funds Social Security and Medicare, which support retirement income, disability benefits, and healthcare for eligible individuals.

• Applied to nearly all wages, with separate contribution rates for Social Security and Medicare.

In short, FUTA tax helps workers who are between jobs, while FICA taxes help provide financial and medical security during retirement or disability.

What is the difference between FUTA, SUTA, and FICA?

FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) both fund unemployment insurance programs, but at different levels.  

FUTA is a federal tax paid to the IRS, while SUTA is a state tax collected by individual states.  

Together, they ensure unemployment benefits are available to eligible workers.

FICA (Federal Insurance Contributions Act) is a separate payroll tax shared by employers and employees that funds Social Security and Medicare programs.

How FUTA Affects Payroll Taxes

For small business owners, FUTA tax is just one part of the overall payroll tax landscape.  

It's one of several taxes that employers must handle, including FICA (Medicare and Social Security), state unemployment tax, and income tax withholdings. While FUTA specifically funds unemployment insurance programs, the others fund long-term federal programs like retirement income and healthcare.

Even though FUTA rates are low, typically an effective rate of 0.6% after credits, it’s still important to factor them into your payroll budget. FUTA adds to the total cost of employing each worker, alongside federal and state taxes, benefits, and insurance.

Key Takeaways

FUTA requires most employers to pay a federal payroll tax that helps fund unemployment benefits for workers who lose their jobs through no fault of their own. This tax is paid entirely by employers and is not deducted from employee wages.

In most cases, employers pay FUTA tax on the first $7,000 of each employee’s annual wages. Those who also pay their state unemployment taxes on time may be eligible for a credit of up to 5.4%, reducing the overall FUTA rate to just 0.6%.

Staying organized with your payroll calendar and submitting Form 940 and quarterly payments on time can help your business avoid unnecessary penalties and keep operations running smoothly. Managing FUTA alongside other payroll taxes may seem complicated, but with the right tools, it becomes much easier.  

If managing FUTA and other payroll taxes feels overwhelming, SurePayroll® By Paychex can help simplify payroll with easy, automated tools so you can focus on your business.  

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