What Is the Federal Unemployment Tax Act (FUTA)?

The Federal Unemployment Tax Act is a federal payroll tax that funds the country’s unemployment insurance system. Employers pay it out of pocket on the first $7,000 of wages paid to each employee per year. Nothing is withheld from worker paychecks. The statutory rate is 6.0%, but most employers pay an effective rate of just 0.6% after claiming a credit for participating in their state’s unemployment program. The revenue covers the administrative costs of state unemployment offices, claims processing, and job service programs.¹

Which Employers Owe FUTA

General employers meet the liability test in one of two ways. You owe FUTA if you paid at least $1,500 in wages during any calendar quarter in the current or preceding year, or if you employed at least one person for any part of a day in 20 or more different weeks during either year.¹ The weeks don’t have to be consecutive, and the workers counted across those weeks don’t have to be the same people. Either test alone triggers liability.

Household employers use a different threshold. If you paid $1,000 or more in cash wages to household employees in any calendar quarter, you owe FUTA on those wages.² Farm employers face a higher bar: FUTA applies only if you paid $20,000 or more in cash wages during any quarter, or you employed 10 or more farm workers for some part of a day in 20 different calendar weeks.³

Employers That Are Exempt

Wages paid by a 501(c)(3) religious, charitable, or educational organization are exempt from FUTA, provided the payments are at least $100 for the year and are otherwise subject to Social Security and Medicare taxes.⁴ State and local governments and their political subdivisions are also outside the tax.⁵ Federally recognized Indian tribes can avoid FUTA by electing to participate in their state’s unemployment system, either by making the required payments or reimbursing the state for claims paid to former employees. Private businesses operating on tribal land don’t qualify.⁶

Some family employment is also excluded. Wages paid to your child under 21 working for your sole proprietorship, or for a partnership where both partners are the child’s parents, are exempt. Wages paid to a parent working for their child’s sole proprietorship are exempt. Services performed for a spouse are not FUTA employment at all.⁷ These carve-outs disappear once a corporation or an unrelated partner enters the picture. Students working for the school where they are enrolled may also be exempt, provided the job is secondary to their education; full-time employees who happen to take classes do not qualify.

The Rate, the Wage Base, and the State Credit

The statutory FUTA rate is 6.0% on the first $7,000 you pay each employee during the calendar year.¹ Once an employee’s wages cross that cap, you owe no more FUTA on additional pay to that person for the year. For employers with high-wage workers, most of the annual FUTA obligation is done within the first few weeks of the year.

If you pay your state unemployment taxes on time, you claim a credit of up to 5.4% against the federal rate. That drops the effective FUTA rate to 0.6%, or a maximum of $42 per employee per year.⁸ Two situations can cut into that credit.

Credit Reduction States

When a state borrows from the federal government to pay unemployment benefits and doesn’t repay the loan 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, and another 0.3% for each additional year the loan remains outstanding.⁸ An employer in a state that has been in credit reduction for three years loses 0.9% of the credit, pushing the effective FUTA rate from 0.6% to 1.5%.

The Department of Labor typically publishes the final list by November 10.⁹ Any additional tax gets calculated on Schedule A of Form 940.¹⁰

Late State Payments

The 5.4% credit assumes your state unemployment contributions were paid on time. If they weren’t, the credit under Section 3302(a) drops to 90% of what it would otherwise be.¹¹ A late state payment in a single quarter can quietly raise your federal tax bill for the whole year.

What Counts as Wages

The statutory definition is broad: all remuneration for employment, including the cash value of benefits paid in any form.⁵ Hourly pay, salaries, commissions, bonuses, and tips all count toward the $7,000 base.

Employee 401(k) elective deferrals are FUTA wages, even though they reduce income for income tax purposes; the statute specifically overrides the general retirement plan exclusion for deferrals the employee chooses.⁵ Employer matching contributions into a qualified trust are not FUTA wages.

Several other categories are excluded from the $7,000 base:⁵

Employer contributions to qualified retirement trusts under Section 401(a), 403(a), 403(b), and similar arrangements.
Employer payments for medical or hospitalization expenses, sickness and accident disability plans, and workers’ compensation benefits.
Death benefits paid under an employer-established plan.
Section 125 cafeteria plan benefits, as long as they wouldn’t be wages if the plan didn’t exist.
Dependent care assistance excluded from the employee’s income under a qualifying program.

Every dollar correctly identified as excluded extends the time before you hit the per-employee cap.

Employees vs. Independent Contractors

FUTA applies only to employees. If the IRS reclassifies workers you treated as contractors, you owe back FUTA at the full 6.0% on the reclassified wages, and no state credit is available for wages you never reported to the state fund.¹¹ That’s on top of any back Social Security, Medicare, and income tax withholding assessed at the same time.

A narrow group called statutory employees sits between the two categories: delivery drivers paid on commission, full-time life insurance sales agents working primarily for one company, home workers making goods from materials you supply, and full-time traveling salespeople who take orders on your behalf. Whether FUTA applies depends on the specific category and the conditions involved. IRS Publication 15-A covers the details.

Filing Form 940 and Making Deposits

Employers report their annual FUTA obligation on Form 940, the Employer’s Annual Federal Unemployment Tax Return.¹² To complete it you need the year’s total wages by employee, a breakdown of exempt payments, and the amounts paid into each state’s unemployment fund. Employers operating in more than one state or in a credit reduction state also complete Schedule A.¹³

Deposits are quarterly, but only when the running liability crosses a threshold. If your accumulated FUTA liability exceeds $500 in any quarter, you must deposit the tax by the last day of the month following the quarter’s end. If the liability stays at $500 or less, it carries forward to the next quarter until the total finally crosses $500. All federal employment tax deposits must be made electronically, through EFTPS, business Direct Pay, or your business tax account. Paper checks with a voucher are not an option for deposits.¹⁴

The Annual Deadline

Form 940 is due January 31 of the year after the tax period. If you deposited all your FUTA tax on time throughout the year, the deadline moves to February 10.¹⁵ The IRS encourages electronic filing of Form 940 but doesn’t require it for most employers. Certified Professional Employer Organizations are the exception and must file electronically.¹⁰

Late Deposit Penalties

Missing a deposit deadline triggers penalties that escalate with how late the payment arrives:¹⁶

1 to 5 calendar days late: 2% of the unpaid deposit
6 to 15 calendar days late: 5%
More than 15 calendar days late: 10%
More than 10 days after the first IRS notice: 15%

The tiers don’t stack. A deposit that’s 20 days late incurs a 10% penalty, not 2% plus 5% plus 10%. Failing to file Form 940 by the deadline is a separate penalty of 5% of the unpaid tax for each month the return is late, up to 25%.

Recordkeeping

Keep all employment tax records, including copies of Form 940, deposit confirmations, and the underlying payroll data, for at least four years after filing the fourth-quarter return for that year.¹⁷ Records for tax year 2026, for example, should be retained through at least early 2031.

The records that matter most in an audit are the ones documenting your exempt payments and your state unemployment tax contributions, because those two figures directly determine your FUTA liability and your credit. If an examiner finds wages that were never reported to the state fund, no state credit is available on those wages and the IRS assesses the full 6.0% rate.¹¹ Confirmation numbers and dates for every state payment are the practical proof that protects the 5.4% credit.

1
Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements
2
Internal Revenue Service. Publication 926 – Household Employer’s Tax Guide
3
U.S. Department of Labor. Unemployment Insurance Tax Topic
4
Internal Revenue Service. Section 501(c)(3) Organizations – FUTA Exemption
5
Office of the Law Revision Counsel. 26 USC 3306 – Definitions
6
Internal Revenue Service. Federal Unemployment Tax (FUTA) Exception for Tribes
7
Internal Revenue Service. Family Employees
8
Internal Revenue Service. FUTA Credit Reduction
9
U.S. Department of Labor. FUTA Credit Reductions – Unemployment Insurance
10
Internal Revenue Service. Instructions for Form 940
11
Internal Revenue Service. Determining Employment Tax Liability
12
Internal Revenue Service. About Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
13
Internal Revenue Service. Schedule A (Form 940) – Multi-State Employer and Credit Reduction Information
14
Internal Revenue Service. Depositing and Reporting Employment Taxes
15
Internal Revenue Service. Employment Tax Due Dates
16
Internal Revenue Service. Failure to Deposit Penalty
17
Internal Revenue Service. Employment Tax Recordkeeping