Will your business owe FUTA taxes in 2020? How much is the FUTA tax and how do you calculate it? Here are a few things you need to know about the federal unemployment tax so you can maintain compliance and avoid costly penalties in 2020.
What is the FUTA tax?
Established on the heels of the Great Depression, the Federal Unemployment Tax Act (FUTA) of 1939 allocates funding for the Unemployment Compensation program. The program is jointly funded via federal and state unemployment taxes (known as SUTA taxes) and is designed to compensate workers who have involuntarily lost their jobs. The program mandates that employers must pay a tax based on a percentage of wages paid to employees. Unlike some taxes, the FUTA tax is paid entirely by employers. Employees are not responsible for any portion of the tax and it is not deducted from employee wages or subject to withholdings.
Who must pay FUTA taxes? Who is exempt from paying FUTA?
In general, you’re subject to FUTA taxes if your business:
- 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 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
Those rules mean most employers must pay FUTA taxes. There are some exemptions, notably 501(c)(3) organizations that are also exempt from paying income tax under 401(a). The FUTA tax also does not apply to contract workers, who are not considered employees. The FUTA tax is levied on payroll wages, but some types of compensation are not factored into employee wages. These are known as FUTA exempt payments and include:
- Fringe benefits such as meals and lodging, contributions to certain health plans and cafeteria plan payments
- Group term life insurance
- Retirement and pension plans, such as contributions to SIMPLE retirement accounts and 401(k) plans
- Certain types of dependent care
- Non-cash payments for agricultural labor
- Payments made under worker’s compensation law
- Payments for domestic services, if total cash wages are less than $1,000 for any calendar quarter
- Payments for services provided by your parent, spouse or child under age 21
- Payments for certain fishing activities, statutory employees and nonemployees treated as employees by state unemployment agencies
You can find more information about FUTA exempt payments on Instructions for Form 940. Always be sure to check with your legal counsel to determine whether any payments you make to employees are exempt from the FUTA tax.
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. However, most businesses qualify for a maximum tax credit of 5.4%. That means your FUTA tax is capped at $42 per employee ($7,000 X .006 = $42). To qualify for the maximum tax credit, your business must have paid its FUTA and SUTA quarterly deposits on time and in full. In addition, your state must not be a “credit reduction state.” The good news is that as of 2020, no U.S. states are considered credit reduction states (only one territory, the Virgin Islands, is in a credit reduction state). That means if you pay your FUTA and SUTA taxes on time, you’re probably eligible for the maximum tax credit.
When are FUTA taxes due?
You should pay FUTA taxes quarterly unless your liability for any quarter is less than $500. In that case, the amount rolls over to the next quarter, and you should pay your tax liability when the collective amount reaches $500 or more. You can use EFTPS to make FUTA quarterly deposits by the last day of the first month that follows the end of the quarter (if that day falls on a weekend or legal holiday, the deadline is the next business day). You should report FUTA taxes annually on Form 940, which must be filed by January 31. However, if you make your quarterly payments on time the IRS automatically extends that deadline to February 10. Note that late FUTA deposits and filings could subject your business to IRS penalties, as follows: You could also be subject to penalties if you file your Form 940 late: 5% per month, up to 25% of your tax liability. The IRS could additionally assess interest fees on unpaid taxes, and you could risk losing your FUTA tax credit, which can have a major impact on your bottom line. For example, if you have 10 employees who each make more than $7,000, your FUTA tax would be calculated based on a total of $70,000 in wages. At the 0.6% tax rate, your liability would be $420. If you make late payments and must pay the full 6%, however, your liability would be $4,200 – an increase of $3,780. And that’s before penalties and interest imposed by the IRS.
How much is federal unemployment tax for your business? How to calculate the FUTA tax
As mentioned, the FUTA tax applies to the first $7,000 in wages paid to each employee. You can calculate your liability by adding up all eligible payments made to employees (capped at $7,000 each), then multiplying the sum by the FUTA tax rate.
FUTA tax challenges
The federal unemployment tax seems straightforward, but in practice it can prove challenging for many businesses. Here are some of the obstacles your business might face.
Tracking employee time and salaries
If you have many employees, or you have part-time employees whose hours and payments vary, it can be difficult to keep track of quarterly compensation. When you have a lot of factors to consider, including fringe benefits and other types of compensation, using a spreadsheet may prove difficult. Make a mistake on quarterly FUTA payments or on end-of-year reporting, and you could be subject to penalties plus jeopardize your FUTA tax credit.
Which workers are considered employees, and which are contractors? Are any employees exempt from FUTA taxation? It’s important to properly classify employees to ensure accurate reporting and on-time payments in full.
Are any employee payments exempt from the FUTA tax? Do you offer fringe benefits, health care coverage, retirement plans, personal use of company vehicles or offer payments for company-related meals and lodging? If you don’t know how to categorize compensation and which payments count toward the FUTA tax, you could make costly mistakes.
Doing the math
Our example calculations are simple, but they become increasingly complicated when you have many employees, different types of employees and different types of compensation categories. If you’re not sure your calculations are accurate, you’re taking a potential risk that could incur penalties and loss of tax credits.
Paying and filing on time
You’re busy running a business, so it’s no wonder FUTA quarterly deposit deadlines can easily sneak up on you. Moreover, filing end-of-year taxes can be cumbersome and time-consuming; a distraction from business operations that ultimately costs more than it’s worth. If you struggle to meet tax deadlines or to find the time to properly prepare your taxes, it might be time to partner with an expert who can help.
How to comply with FUTA tax regulations
You could go it alone, but that presents challenges many employers don’t want to deal with. You could hire an in-house payroll department (and you might already have one), but they’re also busy handling daily operations and might not be up to date with the latest tax codes. That’s why many businesses seek outsourced payroll and tax filling services to either handle all their reporting and filing or augment their in-house staff. Deluxe Payroll can help. From a fully integrated time and attendance solution to compliance and risk management, Deluxe Payroll has a suite of tools designed to help you meet your tax obligations and comply with federal, state, county and city tax codes.
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.
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It’s important to understand FUTA and how to help your business remain compliant in 2020 in order to avoid potential penalties. Here's what you need to know.