Federal Unemployment Tax Act (FUTA): Rates, Form 940, and Deposits

The Federal Unemployment Tax Act imposes a 6.0% federal payroll tax on the first $7,000 of wages paid to each employee per calendar year, but most employers pay just 0.6% after claiming a 5.4% credit for their state unemployment contributions.¹ The tax funds the administrative side of state unemployment offices and a shared federal loan account that states can draw on during downturns. Employers pay it directly. Nothing is withheld from workers’ paychecks.

Who Owes FUTA

Most businesses with employees are liable. The IRS applies a general test with two triggers, and meeting either one puts you on the hook: you paid wages of $1,500 or more in any calendar quarter during the current or prior year, or you had at least one employee for any part of a day in 20 or more different weeks during either year. The weeks don’t need to be consecutive, and the employee doesn’t have to be the same person throughout.¹

Household and farm employers use different thresholds. If you pay cash wages of $1,000 or more in any quarter to workers in your private home, you owe FUTA on those wages.² Agricultural employers become liable at $20,000 or more in cash wages to farmworkers in any quarter, or when they employ 10 or more workers for any part of a day in 20 different weeks (again, not necessarily consecutive, and not necessarily the same 10 people).³

Corporate officers count as employees. When an officer performs services for the corporation and receives compensation, those payments are wages subject to FUTA, including in an S corporation.⁴

Employees Versus Independent Contractors

FUTA applies only to employees. Getting the classification wrong is one of the costlier payroll mistakes, because a worker reclassified as an employee triggers back FUTA plus penalties and interest. The IRS weighs three categories of evidence: behavioral control (whether you direct how the work is done), financial control (whether you control how the worker is paid and who supplies tools), and the type of relationship (benefits, whether the work is a key part of your business, and any written contract). No single factor decides it.⁵

If you’re genuinely unsure, you can file Form SS-8 to ask the IRS for an official determination before the question surfaces in an audit.⁵

Employers That Are Exempt

Three broad categories sit outside FUTA. Organizations described in section 501(c)(3) of the Internal Revenue Code (religious, charitable, and educational nonprofits) do not owe FUTA on employee wages, though those wages remain subject to Social Security and Medicare taxes.⁶

State and local governments and their wholly owned instrumentalities are also exempt. Services performed for these entities fall outside FUTA’s definition of “employment” under 26 U.S.C. § 3306(c)(7).⁷ States still cover these workers under their own unemployment programs.

Federally recognized Indian tribal governments are exempt as long as they stay current on state unemployment obligations, and the exemption extends to subdivisions and wholly owned tribal business enterprises. A tribe that fails to make required state contributions and doesn’t correct the delinquency within 90 days of receiving notice loses its FUTA-exempt status until the problem is resolved.⁸

The Rate, the Credit, and Credit Reduction States

The statutory rate is 6.0% of taxable wages. Almost every employer pays much less, because paying state unemployment tax on time in a state whose trust fund is in good standing earns a credit of up to 5.4%. That brings the effective federal rate to 0.6%.¹

One point that catches employers off guard: you receive the full 5.4% credit as long as you’re required to pay into your state system and actually do so. Your state may assign you a lower contribution rate based on experience rating, and even if your state rate is, say, 2.1%, you still get the full 5.4% FUTA credit. The federal credit is calculated as if you had paid at 5.4%, not on what you actually paid the state.⁹

Credit Reduction States

When a state borrows from the federal unemployment trust fund and doesn’t repay within two years, the U.S. Department of Labor designates it a “credit reduction state.” Employers there lose 0.3% of the credit for the first year the designation applies, another 0.3% for the second year, and an additional 0.3% for each year the loan remains unpaid. An employer in a state with a 0.3% reduction gets a 5.1% credit, so the effective FUTA rate becomes 0.9%.⁹

Employers absorb the reduction; it can’t be passed to employees. The Department of Labor publishes the list of affected states each November, so verify the designation before preparing your annual Form 940.¹⁰

What Counts as Taxable Wages

FUTA applies to the first $7,000 you pay each employee per calendar year. Once a worker’s cumulative wages cross that threshold, you owe no more FUTA on additional pay to that person for the year.¹ State unemployment wage bases are a separate matter and run anywhere from $7,000 up past $78,000, so you’ll often finish paying FUTA on a worker well before you’ve met the state obligation.

Payments Excluded from FUTA Wages

Federal law carves out several categories of payments from FUTA’s definition of “wages.”¹¹ Employer contributions to plans covering medical expenses, hospitalization, sickness, or accident disability for employees and their dependents are excluded. So are employer payments into qualified retirement plans, including 401(a) trusts, 403(a) annuity plans, 403(b) contracts, SEPs, and governmental deferred compensation plans. Group-term life insurance provided by the employer is excluded, as are payments under a qualifying dependent care assistance program.

Employer-provided educational assistance is excluded up to $5,250 per year under a qualifying section 127 plan.¹² Wages paid to your child under age 21 working in your sole proprietorship, or in a partnership where every partner is the child’s parent, are also excluded. That exemption does not apply if the business is a corporation, even one controlled by the parent.¹³

Overstating taxable wages means overpaying; understating them invites penalties on audit. Payroll software generally tracks the exclusions automatically, but verify against the current Form 940 instructions before filing.

How State Unemployment Tax Fits In

FUTA and state unemployment taxes work as a pair. The federal tax funds administrative costs of state unemployment programs and a shared loan account for states that run short. State unemployment taxes (SUTA or SUI) fund the actual benefits paid to unemployed workers. Employers pay both.

Your state assigns a contribution rate based on experience rating, essentially your history of former employees drawing unemployment. New employers usually get a standard starter rate. Businesses with fewer claims earn lower rates over time; those with frequent layoffs pay more. State rates generally run from near zero to over 10%. Alaska, New Jersey, and Pennsylvania also require small employee contributions to the state unemployment fund. Paying state unemployment taxes on time and in full is what unlocks the 5.4% FUTA credit. Fall behind on state payments and you risk losing part or all of that credit, which multiplies your federal bill.

Filing Form 940

Employers report their annual FUTA obligation on Form 940, the Employer’s Annual Federal Unemployment Tax Return. You’ll need your Employer Identification Number and the year’s data:¹⁴

Total wages paid to all employees, including amounts above the $7,000 wage base and excluded payments.
The total of payments excluded from FUTA wages.
The portion of each employee’s pay that exceeded the $7,000 cap.
State unemployment taxes paid, which supports your 5.4% credit claim.
Any credit reduction adjustments that apply if you operate in a credit reduction state.

Part 2 calculates your taxable wage base, Part 3 handles adjustments, and the result is your total FUTA tax for the year, offset by deposits already made during the year.

Multi-State Employers

If you paid unemployment taxes in more than one state, check the multi-state employer box on Form 940 (Part 1, line 1b) and attach Schedule A. Schedule A lists each state where you paid contributions and the taxable wages attributable to each. Any state carrying a credit reduction requires a state-by-state calculation.¹⁵

Successor Employers

If you acquired substantially all of another business’s property and immediately employed one or more of its workers, you qualify as a successor employer. Check box “b” in the Type of Return section on Form 940. You can then count wages the prior owner already paid to those continuing employees toward the $7,000 FUTA wage base, provided the predecessor was itself required to file Form 940. That prevents the same worker’s wages from being taxed twice in an acquisition year.¹⁵

Deposit Deadlines and Payment Methods

FUTA deposits are due quarterly, but only when your cumulative liability crosses a threshold. If your FUTA liability exceeds $500 for a quarter (including carryover from earlier quarters), deposit the full amount by the last day of the month following the quarter’s end: April 30, July 31, October 31, and January 31 for Q1 through Q4. If liability stays at $500 or below, carry it into the next quarter.¹⁶

All federal tax deposits must be made electronically. The IRS offers the free Electronic Federal Tax Payment System (EFTPS), and you can also pay through your IRS business tax account or Direct Pay for businesses.¹⁶

The annual Form 940 is due January 31 of the following year. If that date falls on a weekend or holiday, the deadline shifts to the next business day. If you deposited all of your FUTA on time throughout the year, you get until February 10 to file the return.¹⁷

Penalties

Three separate penalties can apply, and they stack, so one missed deadline can trigger more than one.

Failure to file: 5% of the unpaid tax for each month or partial month the return is late, up to 25%.¹⁸
Failure to pay: 0.5% of the unpaid tax for each month it remains outstanding, also capped at 25%.¹⁹
Failure to deposit: 2% if up to 5 days late, 5% if 6 to 15 days late, 10% if more than 15 days late, and 15% if the tax still isn’t deposited within 10 days of the IRS’s first delinquency notice.²⁰

Interest accrues on all of these from the due date. The failure-to-file penalty is the harshest, so file the return even if you can’t pay in full.

Correcting Errors and Keeping Records

There is no separate “940-X” amendment form. To fix an error on a previously filed Form 940, file a new Form 940 and check the “amended return” box in the top right corner. Amended returns can be e-filed.²¹

To claim a refund on overpaid FUTA, you have three years from the date you filed the original return or two years from the date you paid the tax, whichever is later. If you never filed the return, you have just two years from the payment date.²² If you’re correcting an underpayment, pay the additional tax when you file the amended return to stop further interest.

Keep all employment tax records supporting your Form 940 for at least four years after filing the fourth-quarter return for the year. Records should include total wages paid to each employee, the taxable amounts, your state unemployment contributions, and any excluded payments you claimed.²³

1
Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements
2
Internal Revenue Service. Topic No. 756, Employment Taxes for Household Employees
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U.S. Department of Labor. Unemployment Insurance Tax Topic
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Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers
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Internal Revenue Service. Independent Contractor (Self-Employed) or Employee?
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Internal Revenue Service. Section 501(c)(3) Organizations – FUTA Exemption
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Office of the Law Revision Counsel. 26 U.S. Code 3306 – Definitions
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Internal Revenue Service. FUTA Exemption for Indian Tribal Governments
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Internal Revenue Service. FUTA Credit Reduction
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U.S. Department of Labor. FUTA Credit Reductions
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Office of the Law Revision Counsel. 26 USC 3306 – Definitions
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Internal Revenue Service. Updates to Frequently Asked Questions About Educational Assistance Programs
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Internal Revenue Service. Tax Treatment for Family Members Working in the Family Business
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Internal Revenue Service. Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return
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Internal Revenue Service. Instructions for Form 940
16
Internal Revenue Service. Employment Tax Due Dates
17
Internal Revenue Service. Instructions for Form 940
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Internal Revenue Service. Failure to File Penalty
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Internal Revenue Service. Failure to Pay Penalty
20
Office of the Law Revision Counsel. 26 U.S. Code 6656 – Failure to Make Deposit of Taxes
21
Internal Revenue Service. Correcting Employment Taxes
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Office of the Law Revision Counsel. 26 U.S. Code 6511 – Limitations on Credit or Refund
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Internal Revenue Service. Employment Tax Recordkeeping