What Is Unemployment Insurance Tax? FUTA, SUTA, and the 5.4% Credit

Unemployment insurance tax is a payroll tax that employers pay to fund temporary cash benefits for workers who lose their jobs through no fault of their own. It has two layers. The federal layer, imposed by the Federal Unemployment Tax Act (FUTA), is 6.0% of the first $7,000 of each employee’s annual wages, though a credit for state unemployment taxes typically drops the effective rate to 0.6%.¹ The state layer, usually called SUTA or SUI, is a separate tax with its own rate and wage base set by each state. Together they pay for the weekly benefit checks laid-off workers rely on while they look for new work.

The Federal Piece: FUTA

FUTA is paid entirely by the employer. Nothing comes out of the employee’s paycheck.¹ The gross rate is 6.0% on each employee’s first $7,000 of wages in a year, so the maximum possible FUTA tax before credits is $420 per employee.² Once a worker’s year-to-date pay passes $7,000, no more FUTA applies to that worker for the rest of the year.

The money supports the administrative side of the unemployment system and acts as a backstop. When a state’s own trust fund runs low, the federal government can advance money from the Federal Unemployment Trust Fund under Title XII of the Social Security Act, and the state repays with interest.³

You report FUTA once a year on Form 940. It’s due January 31 for the prior year, or February 10 if you made all required deposits on time.⁴

The State Piece: SUTA

State unemployment tax is what actually pays the weekly benefits to eligible former workers. Every state runs its own program, and the rules diverge sharply. The clearest difference is the taxable wage base: the federal base is $7,000, but state bases range from $7,000 to well over $60,000.⁴ A higher base means state tax applies to a larger slice of each employee’s pay.

In most states only employers contribute. Three states also require small employee contributions withheld from paychecks.⁵ If you operate in more than one state, expect a separate account, rate, and filing schedule in each.

When You Become Liable

Not every business owes unemployment tax from day one. You become liable in the current or preceding calendar year once you cross either of two thresholds:

You paid $1,500 or more in total wages in any single calendar quarter, or
You had at least one employee working for some part of a day in 20 or more different weeks. The weeks do not have to be consecutive.

Meeting either test triggers both FUTA and state unemployment tax.⁶ Payments to independent contractors don’t count toward the $1,500 threshold and aren’t subject to unemployment tax, because contractors are not employees under the statute.⁴

Household and Farm Employers

Different tests apply if you hire household workers, such as nannies, housekeepers, or home health aides. You owe FUTA once you pay $1,000 or more in cash wages to household employees in any calendar quarter, and the tax then applies to the first $7,000 of each household employee’s wages.⁷

Farm employers become liable once they either pay $20,000 or more in wages for farm labor in any calendar quarter, or employ 10 or more farm workers for some part of a day in 20 different weeks during the current or preceding year.⁸

The 5.4% Credit That Drops FUTA to 0.6%

The 6.0% federal rate is rarely what you actually pay. Employers who stay current on their state unemployment taxes can claim a credit of up to 5.4% against FUTA, cutting the net federal rate to 0.6%, or roughly $42 per employee per year on the $7,000 base.⁹¹⁰

To get the full credit, three things have to be true: you paid all state unemployment tax in full, you paid it by the Form 940 due date, and your state is not a credit reduction state.⁴ Paying state taxes late trims the credit to 90% of what you would otherwise get.

Credit Reduction States

When a state borrows from the Federal Unemployment Trust Fund and hasn’t repaid within two years, employers in that state lose part of their FUTA credit. The reduction starts at 0.3 percentage points and grows by another 0.3 points for each additional year the balance stays outstanding.¹¹ In a first-year reduction state, the effective FUTA rate rises from 0.6% to 0.9%, about $21 more per employee on the $7,000 base. Further reductions can kick in starting in the third and fifth years if the state misses repayment benchmarks.

Two jurisdictions had credit reductions for the 2025 tax year after missing the November repayment deadline.¹² The IRS updates the list every year after the November 10 cutoff, so check the current schedule before filing. If your state is listed, you calculate the extra tax on Schedule A (Form 940).

Why Your State Rate Isn’t Flat

Your state unemployment tax rate isn’t one number that applies to every business. States use experience rating, which adjusts each employer’s rate based on how much its former workers have drawn from the state fund. Businesses whose ex-employees file many claims pay more; businesses with stable workforces pay less.

Most states use one of two formulas. The reserve-ratio method compares taxes paid in against benefits charged out, divided by average payroll over roughly three years. The benefit-ratio method compares benefits paid to former workers against the employer’s taxable wages over a similar window.¹³ Either way, the result lands somewhere inside a range set by state law, running from near zero for the most stable employers to 7% or more for the least stable.

A new business has no history, so states assign it a standard starting rate, usually somewhere between 1% and 4%, until enough data accumulates. After two or three years of operation, the state recalculates using your actual experience.

Deposits, Deadlines, and Penalties

FUTA is filed annually but deposited during the year if the amount is large enough. Once your cumulative FUTA liability hits $500 or more at the end of any calendar quarter, you have to deposit the full amount by the last day of the following month: April 30, July 31, October 31, or January 31.¹⁴ If the balance stays under $500 at the end of a quarter, it rolls forward. A fourth-quarter balance under $500 can be paid with Form 940 by January 31.

Missing the deadlines is expensive. The IRS charges a failure-to-file penalty of 5% of the unpaid tax for each month or partial month the return is late, capped at 25%.¹⁵ A separate failure-to-pay penalty runs 0.5% per month. If the return is more than 60 days late, a minimum penalty applies. Interest also accrues on any unpaid balance and compounds daily; the underpayment rate for the first quarter of 2026 is 7%.¹⁶

Late state unemployment payments carry their own penalties, which vary by jurisdiction. They also cost you the full FUTA credit, so a missed state deadline can hit you twice.

Who’s Exempt

Some employers don’t owe FUTA even if they have employees. Organizations that qualify as tax-exempt under Section 501(c)(3) of the Internal Revenue Code, including charities, religious organizations, and educational institutions, are exempt from FUTA on wages paid to their employees.¹⁷ These organizations may still have state unemployment obligations, and many states let nonprofits either pay the standard tax or reimburse the state dollar-for-dollar when a former employee collects benefits.

Certain workers are also excluded from FUTA coverage regardless of who employs them, including some insurance agents paid solely on commission and certain services performed outside the United States.⁶

1
Office of the Law Revision Counsel. 26 USC 3301 – Rate of Tax
2
Internal Revenue Service. Publication 15-A (2026), Employer’s Supplemental Tax Guide
3
Office of the Law Revision Counsel. 42 USC Chapter 7, Subchapter XII – Advances to State Unemployment Funds
4
Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements
5
Employment & Training Administration – U.S. Department of Labor. State Unemployment Insurance Benefits
6
Office of the Law Revision Counsel. 26 USC 3306 – Definitions
7
Internal Revenue Service. Publication 926 (2026), Household Employer’s Tax Guide
8
Employment & Training Administration – U.S. Department of Labor. Unemployment Insurance Tax Topic
9
Office of the Law Revision Counsel. 26 USC 3302 – Credits Against Tax
10
Department of Labor – Office of Unemployment Insurance. Federal Unemployment Tax Act – Unemployment Insurance Tax Fact Sheet
11
Internal Revenue Service. FUTA Credit Reduction
12
Federal Register. Notice of the FUTA Credit Reductions Applicable for 2025
13
U.S. Bureau of Labor Statistics. The Cost of Layoffs in Unemployment Insurance Taxes
14
Internal Revenue Service. Employment Tax Due Dates
15
Internal Revenue Service. Failure to File Penalty
16
Internal Revenue Service. Quarterly Interest Rates
17
Internal Revenue Service. Section 501(c)(3) Organizations – FUTA Exemption