The Federal Unemployment Tax Act (FUTA) requires employers to pay a federal tax that helps fund unemployment benefits for workers who lose their jobs. This tax applies to the first $7,000 in wages paid to each employee each year and is paid entirely by the employer. It is not withheld from employee pay.

FUTA works in conjunction with state unemployment programs. Employers typically receive a credit against their federal tax liability when state unemployment taxes are paid in full and on time, which can significantly reduce their effective tax rate.

Employers must file Internal Revenue Service (IRS) Form 940 annually and make quarterly deposits if their FUTA liability exceeds $500 in a quarter.

FUTA Tax Basics

FUTA is an employer-only federal payroll tax that supports the national unemployment insurance system.

Employers may qualify for a reduced tax rate by paying state unemployment taxes in full and on time. If operating in a credit reduction state, the federal rate may be higher due to outstanding state-level loan balances.

Key facts about FUTA tax include:

• Employer-only tax: Employees do not contribute to FUTA.

• Tax rate: The base FUTA tax rate is 6% on the first $7,000 of wages paid to each employee annually.

• Maximum tax: $420 per employee per year (if no credits apply).

Employers use IRS Form 940 to report annual FUTA liability. If the quarterly total exceeds $500, payment must be deposited electronically by the IRS deadline. Timely filing and deposits help maintain accurate payroll reporting and reduce the risk of penalties.

Tax Credit for State Unemployment Contributions

Employers who pay into state unemployment insurance programs may qualify for a tax credit that reduces their FUTA liability. This credit lowers the effective federal tax rate and can have a meaningful impact on overall payroll costs.

The maximum credit available is 5.4%, which brings the FUTA rate from 6% down to 0.6% on the first $7,000 of wages per employee. To receive the full credit, state taxes must be paid on time and in full. Employers operating in multiple states may see differences in how this credit applies based on each state’s unemployment funding status.

States that borrow from the federal government to cover unemployment benefits and fail to repay on schedule may be designated as credit-reduction states. When this happens, the credit available to employers in that state is reduced, which increases the net FUTA tax rate and overall tax liability. The IRS publishes a list of these states annually. Employers should monitor these updates to avoid surprises during year-end tax calculations.

Credit Reduction States

A credit reduction state has an outstanding balance on federal loans used to pay unemployment insurance benefits and has not repaid them by the specified due date. When this occurs, employers in that state are subject to a FUTA credit reduction, which increases their effective federal tax rate.

This matters because the increased rate raises the employer’s annual federal unemployment tax liability for each affected employee. The designation is determined each calendar year by the U.S. Department of Labor and published by the IRS.

Employers must apply the correct higher rate when preparing their FUTA tax return, especially those operating in multiple states or managing payroll across subsidiaries, franchises or affiliates. Keeping current on state designations helps maintain accuracy in tax payment schedules and compliance at the federal level.

Filing Requirements

Most employers must file Form 940 each year to report their FUTA liability.

This applies generally applies to businesses that:

• Paid $1,500 or more in wages in any calendar quarter

• Had one or more employees for part of a day in at least 20 different weeks during the year

Form 940 covers the full calendar year and is typically due Jan. 31 of the following year. If FUTA liability exceeds $500 in a quarter, the amount must be deposited electronically through the Electronic Federal Tax Payment System (EFTPS). Amounts under $500 may be carried forward to the next quarter until the threshold is reached.

Accurate tracking of taxable wages and applicable exemptions supports proper FUTA calculation. Employers must also consider special filing rules if they employ household employees, farmworkers, nannies or operate as nonprofit organizations subject to limited FUTA obligations.