The Federal Unemployment Tax Act (FUTA) requires most employers to pay into a system that compensates workers who have lost their jobs. If you’re an employer in 2020, it’s important to understand how FUTA works and how it may affect your payroll to help your business remain compliant and avoid potential penalties. Here’s what you need to know, including the 2020 FUTA tax rate, how to calculate FUTA tax and when to file and pay FUTA taxes. Editor’s note: This blog post is not intended to be tax advice. Always check with your legal counsel or tax adviser about your specific situation.
What is the FUTA tax rate for 2020?
The 2020 FUTA tax rate is 6%, applied to the first $7,000 earned by each employee. That makes the FUTA tax cap $420 for each employee; in other words, $420 is the greatest amount most businesses should pay per employee. However, many businesses qualify for a maximum tax credit of 5.4%, which reduces their FUTA liability to 0.6%. At that rate, the greatest amount most businesses would pay per employee is $42 ($7,000 X .006).
Where does the tax credit come from?
For many employers, state unemployment taxes are deductible against FUTA taxes, effectively lowering the FUTA rate that the employer pays by as much as 5.4%. This tax credit brings the FUTA tax rate to 0.6%. State unemployment taxes must have been paid in full, on time and on the same wages for an employer to take the offset of state unemployment wages against their FUTA taxes. Revenue from FUTA taxes is sometimes used to help states pay their unemployment obligations if their state unemployment funds have become insolvent. The federal government offers funds as a loan to the state, which must be repaid either via direct repayment or an increase in the FUTA rate for that state. If your state has not repaid the federal government, it is considered a credit reduction state and the full tax credit may not be available to you. The U.S. Department of Labor maintains a list of credit reduction states (currently, only the Virgin Islands is considered a credit reduction state).
Why do businesses pay the FUTA tax? Who is exempt and who must pay?
The FUTA tax is designed to fund insurance payments to unemployed workers who have lost their jobs. Most employers are subject to FUTA taxes. In general, businesses are subject to FUTA taxes if they:
- Had one or more employees for part of a day in 20 or more weeks OR paid wages of $1,500 or more in any calendar quarter
- Paid at least $1,000 in wages to employees working in a household or domestic capacity
- Paid wages of at least $20,000 to farm workers in any calendar quarter, or employed at least 10 farm workers during any day for 20 weeks
Unlike some taxes, the FUTA tax is paid entirely by employers. Employees are not responsible for any portion of the FUTA tax, and it is not deducted from employee wages or subject to tax withholdings. Note that some nonprofit organizations may be exempt from FUTA. In addition, the FUTA tax does not apply to contract workers, since they are not employees. Some types of compensation are exempt from the FUTA tax as well (more on those below).
When do you need to file and pay FUTA taxes?
FUTA taxes are deposited quarterly in most cases. In some cases, the tax may be paid annually. Wages paid, offsets and amounts due are reported annually on Form 940, which must be filed by January 31, 2020; however, if you filed all your quarterly payments on time, the IRS automatically extends that deadline to February 10, 2020. FUTA quarterly deposits must be made via EFTPS by the last day of the first month that follows the end of the quarter (if that date falls on a weekend or legal holiday, the deadline is the next business day). Here’s a list of quarterly due FUTA quarterly tax due dates for 2020, accurate as of publication time:
- Q1 (January 1 – March 31): April 30
- Q2 (April 1 – June 30): July 31
- Q3 (July 1 – September 30): October 31
- Q4 (October 1 – December 31): January 31
Late FUTA deposits and filings could subject your business to IRS penalties. For example, the agency imposes the following penalties on late deposits:
- 1 – 5 days late: 2%
- 5 – 15 days late: 5%
- 16+ days late but paid within 10 days of first IRS notice or paid with tax return: 10%
- Unpaid more than 10 days after first IRS notice: 15%
In addition, if you file your Form 940 late (or fail to file it at all), you could be subject to a 5% penalty per month, up to 25% of your tax liability. The IRS also charges interest on unpaid taxes, and you could risk losing your FUTA tax credit, which would have a profound impact on your future FUTA tax liability.
How the FUTA tax may affect your business in 2020
Though there aren’t major changes to the FUTA tax in 2020, it’s critical for any business to maintain accurate records. These tips can help you comply with FUTA tax laws, minimize tax liabilities and avoid costly penalties.
Accurately track and categorize compensation
Develop a system to meticulously track employee compensation so you can determine exactly how much any given employee was paid per calendar quarter. It’s also important to categorize compensation appropriately so you know which payments might be exempt from the FUTA tax. This is particularly important if you offer fringe benefits, health coverage and retirement/pension contributions.
Classify employees properly
If you have a mix of full-time on-site employees, remote workers and contractors, it’s important to ensure each one is properly classified so you know whether they’re subject to FUTA taxes. The last thing you want to do is bundle contractors in with full-time employees, which could erroneously increase your FUTA tax liability.
Limit employee turnover and/or consolidate positions
Reducing turnover and consolidating positions are two ways to limit your FUTA tax liability. Why? The tax applies to the first $7,000 paid to each employee. That means your tax liability would be less for one employee who earns $50,000 than two employees who earn $10,000 each (you would be taxed on $7,000 for the first employee, but on $14,000 for the other two employees even though you collectively pay them $30,000 less). If you have multiple part-time employees, you might consider consolidating their duties into one full-time job. In addition, happy employees tend to stick around. Fostering a positive work environment can help reduce employee turnover. If you’re constantly replacing employees at a certain position, it behooves you to ask why and how you can limit turnover. That’s because FUTA liability starts over for each employee you hire.
Pay and file on time
Pay your quarterly deposits and file your Form 940 on time, every time, to help you avoid costly penalties and the potential to lose your tax credit. The difference between 6% and .06% can be staggering, especially if you have a lot of employees. For example, let’s say you employee 50 full-time employees and each earns more than $7,000. That means your FUTA tax would be calculated based on a total of $350,000 in wages. At .06%, your tax liability would be $2,100. At 6%, however, it would amount to $21,000 — a difference of $18,900! That doesn’t include potential penalties ranging up to 25% of your total tax liability for late filing or failure to file, plus interest due on late payments. The IRS has made it clear: It’s critical to pay and file FUTA taxes on time, and penalties can be severe if you fail to adhere to that mandate.
Partner with a payroll service
Manual employee, payment and tax liability tracking is cumbersome and error-prone, and many businesses both large and small struggle to maintain the meticulous records needed to comply with FUTA tax rules, avoid penalties and minimize tax liabilities. An experienced payroll service can help. Payroll services make it easy to classify and track employees and wages, categorize types of compensation, prepare FUTA tax deposits and file Form 940 at the end of the year. They’re experienced in navigating tax laws to help your business comply and identify tax advantages that could minimize your overall liability. A good payroll service can not only help with federal FUTA taxes, but also state SUTA taxes, which can vary significantly and complicate the process. Deluxe Payroll offers a variety of payroll management solutions that can help your business remain compliant with FUTA regulations.
Editor's note: This blog post was deemed accurate at the time of publication and may not reflect recent changes related to payroll law. The information provided in this blog does not, and is not intended to, constitute legal or financial advice.