Federal Unemployment Tax Act - Futa Tax

The Federal Unemployment Tax Act (or FUTA, I.R.C. ch. 23) is a United States federal law that imposes a federal employer tax used to help fund state workforce agencies. Employers report this tax by filing an annual Form 940 with the Internal Revenue Service. In some cases, the employer is required to pay the tax in installments during the tax year.

FUTA covers a federal share of the costs of administering the unemployment insurance (UI) and job service programs in every state. In addition, FUTA pays one-half of the cost of extended unemployment benefits (during periods of high unemployment) and provides for a fund from which states may borrow, if necessary, to pay benefits.

Calculation of amount of tax

Through June 30, 2011, the Federal Unemployment Tax Act imposed a tax of 6.2%, which was composed of a permanent rate of 6.0% and a temporary rate of 0.2%, which was passed by Congress in 1976. The temporary rate was extended many times, but it expired on June 30, 2011.

Consequently, for years through 2010 and the first six months of 2011, the FUTA imposed a 6.2% tax (before credits) on the first $7,000 of gross earnings of each worker per year. Once the worker's earnings reach $7,000 during a given year, the employer no longer pays any Federal unemployment tax for that year with respect to that worker. Certain credits are allowed with respect to state unemployment taxes paid that may reduce the effective FUTA rate to 0.8%.

Effective July 1, 2011, the rate decreased to 6.0%. That rate may be reduced by an amount up to 5.4% through credits for contributions to state unemployment programs under sections 3302(a) and 3302(b), resulting in a minimum effective rate on and after July 1, 2011 of 0.6% (6.0% - 5.4%).

Credit Reduction

The credit against the Federal tax may be reduced if the state has an outstanding advance (commonly called a “loan”). When states lack the funds to pay UI benefits, they may obtain loans from the federal government. To assure that these loans are repaid, and in accordance with Title XII of the Social Security Act, the federal government is entitled to recover those monies by reducing the FUTA credit it gives to employers, which is the equivalent of an overall increase in the FUTA tax. When a state has an outstanding loan balance on January 1 for two consecutive years, and the full amount of the loan is not repaid by November 10 of the second year, the FUTA credit will be reduced until the loan is repaid. This process is commonly called FUTA Credit Reduction and was designed as an involuntary repayment mechanism. The reduction schedule is 0.3% for the first year and an additional 0.3% for each succeeding year until the loan is repaid. From the third year onward, there may be ad ditional reduction(s) in the FUTA tax credit (commonly dubbed "add-ons"). For example, for taxable years 2012 and 2013, Virgin Islands had a "2.7 add-on" when its tax rate on total wages was below a national minimum. For taxable year 2014, Connecticut had a "BCR add-on" when its tax rate on the taxable portion of covered wages in the previous calendar year is less than the 5-year benefit cost ratio applicable for the taxable year.

Based on their loan status on November 10, 2014, there are 8 states (or jurisdiction) that will receive reduced FUTA Credit for taxable year 2014. Employers in these states will pay extra FUTA taxes that are effective retroactively to January 1, 2014.

Below is a list of FUTA Credit Reduction states for taxable year 2009 through 2014, and their respective reduction amounts (in %):

Wages exempt from FUTA

The following wages are exempt from Federal Unemployment Tax Act payments:

1. Wages for services performed outside the United States.
2. Wages paid to a deceased employee or a deceased employee's estate in any year after the year of the employee's death.
3. Wages paid by a parent to a child under age 21, paid by a child to a parent, or paid by one spouse to the other spouse.
4. Wages paid by a foreign government or international organization.
5. Wages paid by a state or local government or by the United States federal government.
6. Wages paid by a hospital to interns.
7. Wages paid to newspaper carriers under age 18.
8. Wages paid by a school to a student of the school.
9. Wages paid by an organized seasonal camp to a full-time student who worked fewer than 13 calendar weeks during the calendar year.
10. Wages paid by non-profit organizations.