The short answer: FUTA is a federal payroll tax paid only by employers to fund unemployment insurance. It is 6.0% of the first $7,000 of each employee’s wages per year, but employers that pay their state unemployment tax on time get a credit of up to 5.4%, so most pay 0.6%, or about $42 per employee. Deposits are due once the running liability passes $500, and the annual return is Form 940, due January 31.
FUTA is a small, capped, employer-only tax, and one of the easiest payroll obligations to get wrong without noticing. Here is who pays it, how the math works, and where the deadlines and traps are.
Key Takeaways
- Employer only: nothing is withheld from employee pay.
- Capped: only the first $7,000 of each employee’s annual wages is taxed.
- Usually 0.6%: the 6.0% gross rate drops to 0.6% with the full credit for state unemployment tax.
- State matters: late state payments shrink the credit, and credit-reduction states (California and the US Virgin Islands for 2025) pay more.
- $500 rule: deposit once your running liability passes $500; otherwise carry it forward.
- Form 940: filed once a year by January 31, or February 10 if every deposit was made on time.
FUTA at a Glance
| Item | Rule |
|---|---|
| Wage base | First $7,000 of each employee's wages per year |
| Gross rate | 6.0% |
| Credit for state unemployment tax | Up to 5.4% |
| Usual net rate | 0.6%, about $42 per employee per year |
| Deposit trigger | Accumulated liability over $500 |
| Annual return | Form 940, due January 31 (February 10 if all tax was deposited on time) |
| Who pays | Employer only; nothing is withheld from employees |
What FUTA Actually Is
FUTA, the Federal Unemployment Tax Act, is a federal payroll tax that employers pay to fund the unemployment insurance system. When a worker loses a job through no fault of their own, the benefits that support them come from a federal and state partnership. FUTA is the federal half.
Two features define it, and both surprise people used to thinking about income tax:
- It is paid entirely by the employer. Nothing is withheld from an employee’s paycheck for FUTA, and it does not reduce anyone’s take-home pay. It is a cost the business bears directly.
- It is capped at a low wage base. FUTA applies only to the first $7,000 of wages you pay each employee in a calendar year. Once a worker passes $7,000, you owe no more FUTA on that person for the rest of the year.
The federal government uses FUTA to pay for administering state unemployment programs, to share the cost of extended benefits, and to lend to states whose unemployment funds run short in downturns. In short, it is an employer-funded safety net that keeps the system solvent nationwide.
FUTA vs. SUTA: The Two Halves of Unemployment Funding
Unemployment insurance is funded by two taxes that work as a pair. They are easy to confuse because they do the same job at different levels of government.
| FUTA | SUTA / SUI | |
|---|---|---|
| Level | Federal | State |
| Collected by | The IRS | Each state's workforce agency |
| Who pays | Employer only | Usually employer only (Alaska, New Jersey and Pennsylvania also tax employees) |
| Rate | One federal rate nationwide | Varies by state and by your claims history (experience rating) |
| Wage base | $7,000 | Set by each state, often much higher |
| Reported on | Form 940 (annual) | State returns (usually quarterly) |
The two are linked by design. Paying your state unemployment tax on time and in full is what earns the large FUTA credit described below. Almost every employer owes both; they are not alternatives.
Who Pays FUTA: The Three Coverage Tests
FUTA is an employer tax. Employees never pay it, and self-employed people do not pay it on their own earnings. A partner’s share of partnership profit is not subject to FUTA, and payments to genuine independent contractors are outside it. The question is whether your business is an employer for FUTA purposes. The IRS uses three tests, and meeting any one of them in the current or the preceding calendar year brings you in.
The General Test
This covers most businesses. You owe FUTA if you paid $1,500 or more in wages in any calendar quarter, or had at least one employee for some part of a day in 20 or more different weeks.
The Household Employee Test
If you employ household workers, such as a nanny, a caregiver or a housekeeper, you owe FUTA once you pay $1,000 or more in cash wages in any calendar quarter.
The Farmworker Test
Agricultural employers owe FUTA if they paid $20,000 or more in cash wages to farmworkers in any calendar quarter, or employed 10 or more farmworkers for some part of a day in 20 or more different weeks.
Quick illustration: you run a small studio and hire two employees in March, paying $9,000 in wages that quarter. You have passed the $1,500 general-test threshold, so you are a FUTA employer for the year and you will file Form 940 the following January. Because the test also looks back one year, you remain covered next year even if payroll drops.
Who Is Exempt from FUTA
Some employers and some payments fall outside FUTA entirely. The common exemptions:
- 501(c)(3) nonprofits: organizations exempt under section 501(c)(3) do not pay FUTA. Most still owe state unemployment tax or reimburse the state for benefits paid.
- Government employers: federal, state and local government employers are generally exempt.
- Employers below the thresholds: if you never meet any of the three tests in the current or preceding year, FUTA does not apply.
- Family employment: wages you pay to your child under 21, your spouse, or your parent are exempt, where the business is a sole proprietorship or, for a child, a partnership owned only by the parents.
- Certain payments: some kinds of compensation, such as certain fringe benefits and employer contributions to qualified retirement plans (employee 401(k) deferrals still count as FUTA wages), are excluded from FUTA wages.
Exemptions are narrower than they look. Confirm your status before assuming you are outside the system, because an incorrect exemption is expensive to unwind.
The FUTA Rate, the Wage Base, and the 5.4% Credit
The gross FUTA rate is 6.0% of the first $7,000 of each employee’s wages, which would be up to $420 per employee per year. Almost no employer pays that much.
The reason is the FUTA credit. If you pay your state unemployment tax on time and in full, you get a credit of up to 5.4% against the federal rate. That brings the net FUTA rate to 0.6%, or at most $42 per employee per year.
What You Pay per Employee
| Situation | Net FUTA rate | Maximum per employee |
|---|---|---|
| No credit (state tax not paid) | 6.0% | $420 |
| Full credit (state tax paid on time) | 0.6% | $42 |
| California, 2025 (1.2% credit reduction) | 1.8% | $126 |
| US Virgin Islands, 2025 (4.5% credit reduction) | 5.1% | $357 |
The same tax can be ten times larger or smaller depending on whether your state unemployment payments are current. The 6.0% rate and $7,000 wage base have not changed in decades and can only be changed by Congress, but confirm the current figures on the IRS Form 940 page each year.
The reason is the FUTA credit. If you pay your state unemployment tax on time and in full, you get a credit of up to 5.4% against the federal rate. That brings the net FUTA rate to 0.6%, or at most $42 per employee per year.
Credit-Reduction States: When the Credit Shrinks
In one situation, employers lose part of the 5.4% credit through no fault of their own. When a state borrows from the federal government to keep paying unemployment benefits and does not repay the loan in time, it becomes a credit-reduction state. The reduction starts at 0.3% and generally grows by another 0.3% for each additional year the loan stays unpaid.
For 2025, the Department of Labor named California (1.2% reduction) and the US Virgin Islands (4.5% reduction). The list is announced each November, so check it before calculating year-end FUTA. The additional tax is reported on Schedule A (Form 940) and treated as a fourth-quarter liability, due by the January due date.
A practical example: your business has 10 employees, each earning more than $7,000, so your FUTA wage base is $70,000. In a normal state your FUTA is $70,000 × 0.6% = $420 for the year. If your state is in its second year of credit reduction, with a 0.6% reduction, your rate rises to 1.2% and the same base produces $840. That is double the bill, an extra $42 per employee, even though nothing about your own payroll changed.
How to Calculate Your FUTA Liability
The calculation is short once you know the moving parts. Work it employee by employee:
- Take each employee’s wages for the year, but count only the first $7,000. Anyone earning $7,000 or more contributes exactly $7,000; anyone earning less contributes their actual wages.
- Add the capped amounts across all employees to get your FUTA wage base.
- Apply the net rate: 0.6% if your state tax is current and your state is not credit-reduced. (Apply 6.0% to see the gross figure before the credit.)
A worked example: you have 8 employees who each earn well over $7,000. Your FUTA wage base is 8 × $7,000 = $56,000. At 0.6%, your FUTA for the year is $336, about $42 each. Before the credit, the same base at 6.0% would be $3,360.
Part-year and lower-paid workers cap out lower. An employee who earned $5,000 for the year contributes $5,000 to the base, so their FUTA is $5,000 × 0.6% = $30.
A Real-World Mix: A Small Cafe
Most payrolls are not uniform. Here is a cafe with a full-time manager, two full-time staff and two part-timers, at the 0.6% rate:
| Worker | Annual wages | FUTA wage base (first $7,000) | FUTA at 0.6% |
|---|---|---|---|
| Manager (full-time) | $52,000 | $7,000 | $42.00 |
| Cook (full-time) | $38,000 | $7,000 | $42.00 |
| Server (full-time) | $24,000 | $7,000 | $42.00 |
| Part-timer A | $6,200 | $6,200 | $37.20 |
| Part-timer B (left mid-year) | $3,000 | $3,000 | $18.00 |
| Total | $123,200 | $30,200 | $181.20 |
The cafe paid $123,200 in wages, but only $30,200 was subject to FUTA, because the three full-time staff each cap at $7,000 and the two part-timers fall under the cap. Total FUTA for the year is $181.20. Because that never passes the $500 deposit threshold, the cafe can pay it with Form 940 instead of depositing during the year.
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Depositing and Reporting: The $500 Rule and Form 940
FUTA has two separate obligations that people often merge: depositing the tax during the year, and reporting it once a year. They run on different clocks.
Depositing During the Year: The $500 Rule
Work out your FUTA liability at the end of each quarter. If the accumulated amount is more than $500, deposit it by the last day of the month after the quarter ends. If it is $500 or less, carry it forward and add it to the next quarter. If it never passes $500 for the year, you can pay it with Form 940.
| Quarter | Period covered | Deposit due by |
|---|---|---|
| Q1 | January 1 to March 31 | April 30 |
| Q2 | April 1 to June 30 | July 31 |
| Q3 | July 1 to September 30 | October 31 |
| Q4 | October 1 to December 31 | January 31 (next year) |
Deposits are made electronically, usually through the Electronic Federal Tax Payment System (EFTPS). When a due date falls on a weekend or legal holiday, it moves to the next business day.
Example: How the Carry-Forward Works
A growing firm builds up FUTA as it hires through the year:
| Quarter | FUTA accrued | Running total not yet deposited | Deposit required? |
|---|---|---|---|
| Q1 | $210 | $210 | No, carry forward |
| Q2 | $260 | $470 | No, carry forward |
| Q3 | $190 | $660 | Yes, deposit $660 by October 31 |
| Q4 | $120 | $120 | Optional; pay with Form 940 or deposit by January 31 |
You deposit only in the quarter your running total first goes over $500, then deal with any smaller remainder at filing.
Reporting Once a Year: Form 940
FUTA is reported on Form 940, the Employer’s Annual Federal Unemployment (FUTA) Tax Return. You file one Form 940 for the year by January 31 of the following year, or by February 10 if you deposited all your FUTA tax on time. When the date falls on a weekend or holiday it moves to the next business day, so the 2026 return is due February 1, 2027. Form 940 is where the credit and any credit reduction are reconciled (using Schedule A if you paid wages in more than one state or in a credit-reduction state), and where a remaining balance of $500 or less can be paid. It can be e-filed or mailed.
FUTA vs. FICA: Don't Confuse the Two
FUTA and FICA are both payroll taxes, but they fund different things and work differently. Mixing them up leads to real reporting errors.
| FUTA | FICA | |
|---|---|---|
| What it funds | Unemployment insurance | Social Security and Medicare |
| Who pays | Employer only | Employer and employee, equal shares |
| Wage limit | First $7,000 | Social Security up to an annual wage cap; Medicare has no cap |
| On the pay stub | Never | Yes, as withholding |
| Reported on | Form 940 (annual) | Form 941 (quarterly) or Form 944 (annual, for small employers) |
The clearest difference: FICA is shared and shows up on the employee’s pay stub; FUTA is the employer’s alone and never does.
Mistakes That Cost Employers Money
FUTA and FICA are both payroll taxes, but they fund different things and work differently. Mixing them up leads to real reporting errors.
1. Withholding FUTA from Paychecks
FUTA is never withheld from employees. Deducting it from wages is wrong and creates a payroll compliance problem that has to be refunded.
2. Forgetting the $7,000 Cap
Applying FUTA to full wages instead of the first $7,000 overstates the tax and signals a payroll setup that needs review.
3. Paying State Unemployment Tax Late
State tax paid after the Form 940 due date earns only 90% of the credit on that amount, and unpaid state tax earns none. Keep state payments current to keep the full 5.4% credit.
4. Ignoring Credit-Reduction Status
Employers in a credit-reduction state owe more than 0.6%. The extra amount belongs in the fourth-quarter liability and is due by the January due date; missing it leads to a balance due, plus possible penalties and interest.
5. Misclassifying Workers
Treating an employee as a contractor to avoid FUTA and other payroll taxes is a common audit issue, with penalties well beyond the tax saved.
6. Missing the $500 Deposit Trigger
Waiting until Form 940 when liability has already passed $500 during the year leads to failure-to-deposit penalties.
Filing on time and calculating on the right base is always cheaper than fixing it later. Clean bookkeeping makes the quarterly check easy.
Frequently Asked Questions
1. What is FUTA?
FUTA, the Federal Unemployment Tax Act, is a federal payroll tax that employers pay to fund the unemployment insurance system. It applies to the first $7,000 of each employee’s wages each year and is reported on Form 940.
2. Do employees pay any part of FUTA?
No. FUTA is paid entirely by the employer. Nothing is withheld from employee wages, and it does not reduce take-home pay.
3. What is the FUTA rate, and why do most employers pay so little?
The gross rate is 6.0% on the first $7,000 of each employee’s wages. Employers that pay their state unemployment tax on time get a credit of up to 5.4%, which lowers the net rate to 0.6%, or about $42 per employee per year.
4. What is a credit-reduction state?
A state that borrowed from the federal government to pay unemployment benefits and did not repay the loan in time. Employers there get a smaller credit, so their FUTA rate is above 0.6%. For 2025, California (1.2% reduction) and the US Virgin Islands (4.5% reduction) were credit-reduction jurisdictions. The Department of Labor announces the list each November.
5. When do I have to deposit FUTA versus pay it with Form 940?
Track your liability each quarter. When the accumulated amount goes over $500, deposit it by the last day of the month after that quarter. If it is $500 or less, carry it forward. If it never goes over $500 for the year, you can pay it with Form 940.
6. When is Form 940 due?
January 31 of the following year. If you deposited all your FUTA tax on time, you have until February 10. When the due date falls on a weekend or legal holiday, it moves to the next business day, so the 2026 return is due February 1, 2027.
7. What happens if I pay state unemployment tax late?
If you pay state unemployment tax after the Form 940 due date, you get only 90% of the credit on the late amount. If you do not pay it at all, you get no credit for it.
8. Does a self-employed person pay FUTA?
No. FUTA does not apply to a sole proprietor’s or partner’s own earnings, and payments to genuine independent contractors are outside it. It applies to wages paid to employees.
9. Are nonprofits exempt from FUTA?
Organizations exempt under section 501(c)(3) do not pay FUTA. Most still have state unemployment obligations, either by paying state tax or by reimbursing the state for benefits paid.
10. Is FUTA the same as the unemployment benefits a worker receives?
No. FUTA is the employer tax that helps fund the system; unemployment insurance is the benefit a laid-off worker collects.
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Parth Shah, Managing Director
(CPA-US, FCA, RV-S&FA, DISA)
Parth Shah who is head of Accounts and Book keeping has experience of more than 10 years. A Certified Public Accountant – US, fellow Chartered Accountant, Registered Valuer and Diploma in Information System Audit.
