What Wages Are Subject to FUTA Tax and What’s Exempt?

FUTA tax applies to the first $7,000 of almost everything you pay each employee during the calendar year, including salary, hourly wages, bonuses, commissions, tips reported to you, vacation and sick pay, and taxable fringe benefits. Health insurance premiums, retirement plan contributions, cafeteria plan elections, and a handful of other benefits are carved out, and several categories of employment sit entirely outside the FUTA system. The tax is 6% on paper, but most employers pay an effective 0.6% after the state unemployment credit, which caps the annual cost at roughly $42 per worker.¹ FUTA falls entirely on the employer and is never withheld from an employee’s paycheck.

The $7,000 Wage Base

The wage base has been $7,000 since 1983. You owe the tax only on the first $7,000 in wages paid to each employee during the calendar year.² After an employee crosses that threshold with you, every additional dollar you pay that person is FUTA-free for the rest of the year.

Track this per employee, per employer. If someone works for you and an unrelated business at the same time, both employers owe FUTA on the first $7,000 each of you pays. State unemployment tax (SUTA) has its own separate wage base, usually much higher, and does not affect the federal $7,000 calculation on Form 940.

Pay That Counts Toward the $7,000

Federal law defines wages broadly: all remuneration for employment, including the cash value of non-cash compensation.² In practice, these all count toward the wage base:

Hourly wages and fixed salaries.
Bonuses, commissions, overtime, back pay, severance, and signing bonuses.³
Vacation pay and sick pay paid directly by the employer. Sick pay becomes exempt once it is paid more than six calendar months after the employee last worked for you.³
Cash and charge tips that an employee reports to you in writing. Employees must report tips of $20 or more in a calendar month.²
Taxable fringe benefits and expense allowances paid under a nonaccountable plan.

Because these payments all count as wages, they stack toward the cap. An employee who earns $5,000 in salary in January and a $3,000 bonus in February has already passed $7,000, so anything you pay that worker for the rest of the year is outside FUTA.

Payments and Benefits Excluded From FUTA Wages

Not everything you spend on an employee is a wage. The statute carves out specific categories, and these exclusions can meaningfully reduce your taxable payroll.

Health, Disability, and Life Insurance

Payments you make under an established plan on account of sickness, accident disability, medical and hospitalization expenses, or death are excluded from the FUTA wage base.² That covers premiums you pay for group health insurance, group-term life insurance, and disability coverage. The plan has to cover your employees generally or a broad class of employees, not a handful of hand-picked individuals.⁴

Retirement Plan Contributions

Employer contributions to qualified retirement plans are not FUTA wages. The exclusion reaches traditional pension trusts, 403(a) annuity plans, 403(b) tax-sheltered annuities, simplified employee pensions (SEPs), SIMPLE IRA plans, and governmental deferred compensation plans.² Employer matching contributions to a 401(k) are excluded. Employee salary deferrals are a different story: an employee’s elective deferrals into a 401(k) or a 403(b) contract are generally still FUTA wages even though they reduce the employee’s income tax.

Cafeteria Plan Elections

Amounts an employee elects to receive as non-taxable benefits through a Section 125 cafeteria plan are excluded from FUTA wages, as long as the underlying benefits would not be treated as wages outside the plan.² A common example: an employee redirects part of their salary to pay health insurance premiums through the plan. That redirected amount is not FUTA-taxable.

Educational Assistance and Dependent Care

Employer-provided educational assistance under a qualified program (up to $5,250 per year) and dependent care assistance (up to $5,000 per year for most filers) are both excluded from FUTA wages, provided the plans meet the requirements of Sections 127 and 129.² These are common benefits that employers sometimes overlook when calculating FUTA.

Qualified Moving Expense Reimbursements

The Tax Cuts and Jobs Act suspended the exclusion for qualified moving expense reimbursements from 2018 through 2025, so those reimbursements were treated as FUTA wages during that stretch (active-duty military members aside). For 2026, the suspension has expired, and qualified moving expense reimbursements are again excludable from FUTA wages for employees who meet the distance and time tests under Section 217.

Employment Relationships Outside FUTA

Separate from the question of which payments count as wages, certain categories of employment are entirely outside the FUTA system. If a working arrangement falls into one of these buckets, the employer owes no FUTA on those wages, no matter the amount.

Government and 501(c)(3) Nonprofit Employers

Services performed for the federal government, state and local governments, and Indian tribal governments are exempt from FUTA.² Services performed for Section 501(c)(3) organizations, including charities, religious organizations, and educational institutions, are also exempt. These employers typically still participate in state unemployment programs, but they do so through alternative arrangements rather than through FUTA.

Family Employment

Three family situations are carved out: a child under 21 working for a parent, one spouse working for the other, and a parent working for a son or daughter.² These exemptions apply to sole proprietorships and partnerships in which every partner is a family member. They do not apply when the employing entity is a corporation or an estate, even if the family relationship exists. This catches people off guard. If you incorporate your family business, you owe FUTA on wages paid to family members just like any other employee.

Agricultural Labor

Agricultural labor is exempt from FUTA unless the employer crosses one of two thresholds: paying $20,000 or more in cash wages for agricultural labor in any calendar quarter, or employing 10 or more agricultural workers on at least 20 different days during the year, each day falling in a separate calendar week.² Small farms that stay below both thresholds owe no FUTA on farm labor. Both thresholds are tested against the current and preceding calendar year, so crossing either one in a given year triggers FUTA liability the following year as well.

Domestic Service

Household employers owe FUTA only if they pay cash wages of $1,000 or more to household employees in any calendar quarter of the current or preceding year.⁵ Once that threshold is met, the standard $7,000 wage base applies to each household worker for the year. Pay a nanny, housekeeper, or other household worker less than $1,000 in every quarter, and you have no FUTA obligation for that worker.

Statutory Employees and Successor Employers

Some workers who look like independent contractors are treated as employees by statute for employment tax purposes: delivery drivers working on commission, full-time life insurance agents selling primarily for one company, home workers producing goods to your specifications, and full-time traveling salespeople turning in orders on your behalf.⁶ If a worker meets the IRS conditions in one of these categories, you owe FUTA on their wages the same as any other employee.

If you acquire another business and immediately hire workers who were employed by the prior owner, you may qualify as a successor employer. In that case, wages the predecessor already paid those workers during the same calendar year count toward the $7,000 cap, so you do not start over at zero.⁷ The successor employer rules in the Form 940 instructions govern whether the acquisition qualifies. If it does not, each employer calculates the wage base independently.

Independent Contractors and Misclassification

Independent contractors are not employees, so their pay is not FUTA wages. Classifying someone as a contractor when they should legally be an employee does not solve the problem: you can be held liable for the employment taxes you should have been paying, including FUTA.⁸ The IRS looks at the degree of control you exercise, the financial arrangement, and the nature of the relationship to decide the classification.

When misclassification is found, Section 3509 sets the liability. If you filed the required information returns (a 1099, for instance) for the worker, your withholding tax liability is reduced to 1.5% of wages paid, and your employee-share FICA liability is reduced to 20% of the normal amount.⁹ If you did not file those returns, the rates double to 3% and 40%. The reduced rates do not apply at all if you had no reasonable basis for treating the worker as a contractor. In that scenario, you owe the full employment tax as if the worker had been classified correctly from the start.

1
Office of the Law Revision Counsel. 26 USC 3301 – Rate of Tax
2
Office of the Law Revision Counsel. 26 USC 3306 – Definitions
3
Internal Revenue Service. Publication 15, Employers Tax Guide
4
eCFR. 26 CFR 31.3306(b)(2)-1 Payments Under Employers Plans
5
Internal Revenue Service. Publication 926, Household Employers Tax Guide
6
Internal Revenue Service. Statutory Employees
7
Internal Revenue Service. Topic No. 759, Form 940 Filing and Deposit Requirements
8
Internal Revenue Service. Independent Contractor (Self-Employed) or Employee
9
Office of the Law Revision Counsel. 26 USC 3509 – Determination of Employers Liability for Certain Employment Taxes