What Is FUTA? Federal Unemployment Tax Act Explained

What Is FUTA? Federal Unemployment Tax Act Explained

Most employers know they’re responsible for payroll taxes. But when FUTA shows up on a tax form, it catches plenty of business owners off guard. What is this tax? Why do you owe it? And how much does it actually cost?

The Federal Unemployment Tax Act (FUTA) funds unemployment benefits for workers who lose their jobs through no fault of their own. Unlike most payroll taxes, FUTA is paid entirely by employers — employees don’t contribute a cent. It’s one of those behind-the-scenes costs of running a business that you can’t afford to ignore, especially if you’re hiring across multiple states.

In this guide, we’ll break down exactly how FUTA works, what the current tax rates are, how to calculate what you owe, and what happens if you operate in a credit reduction state. Whether you’re a startup founder processing your first payroll or an HR leader managing a distributed team, this is what you need to know.

Remote People helps companies hire and manage employees in 150+ countries — including full payroll tax compliance. Talk to our team →

What Is the Federal Unemployment Tax Act (FUTA)?

The Federal Unemployment Tax Act is a federal law that requires employers to pay a tax on wages they pay to employees. The revenue collected through FUTA goes into the Federal Unemployment Trust Fund, which provides funding to state unemployment insurance (UI) programs.

Here’s how it works in practice: when an employee gets laid off, they can file for unemployment benefits through their state. The state pays those benefits using a combination of state unemployment taxes (SUTA) and federal funds provided through FUTA.

FUTA was originally enacted in 1939 as part of the Social Security Act. Its purpose was straightforward — create a safety net for American workers during periods of involuntary unemployment. Nearly a century later, it still serves the same function.

Who Pays FUTA Tax?

FUTA is an employer-only tax. Your employees never see a FUTA deduction on their pay stubs.

You’re required to pay FUTA tax if you meet either of these criteria:

• You paid wages of $1,500 or more to employees in any calendar quarter during the current or previous year
• You had one or more employees for at least some part of a day in any 20 or more different weeks in the current or previous year

Most businesses with employees will meet at least one of these thresholds. Independent contractors, however, don’t count — FUTA only applies to W-2 employees.

FUTA vs. SUTA: What’s the Difference?

It’s easy to confuse FUTA with SUTA (State Unemployment Tax Act), but they’re separate obligations.

FUTA is a federal tax with a uniform rate across all states. It funds the administrative costs of unemployment programs and provides a backstop when states run out of money.

SUTA is a state-level tax with rates that vary by state and by employer. Your SUTA rate typically depends on your industry, the size of your payroll, and your experience rating — basically, how many former employees have filed unemployment claims against your account.

The two taxes work together. In fact, the FUTA credit system directly ties your federal tax liability to whether your state has its unemployment fund in good standing.

Current FUTA Tax Rate and Wage Base

The gross FUTA tax rate is 6.0%. But almost no employer actually pays that full amount.

Here’s why: employers who pay their state unemployment taxes on time receive a credit of up to 5.4% against their FUTA tax. That brings the effective FUTA rate down to just 0.6% for most employers.

The FUTA Wage Base

FUTA tax applies only to the first $7,000 of wages paid to each employee per calendar year. This $7,000 threshold is known as the FUTA wage base.

Once an employee’s cumulative wages for the year exceed $7,000, you stop owing FUTA tax on any additional wages for that employee. This makes FUTA a relatively small per-employee cost compared to other payroll taxes.

Quick math: At the effective rate of 0.6%, the maximum FUTA tax per employee is $42 per year ($7,000 × 0.006). For a company with 50 employees, that’s $2,100 annually — not a huge number, but one that adds up and absolutely must be tracked correctly.

How to Calculate FUTA Tax

Calculating your FUTA obligation isn’t complicated, but it requires attention to detail. Here’s the step-by-step process.

Step 1: Determine Taxable Wages

For each employee, identify total wages paid during the calendar year, up to the $7,000 wage base. If an employee earned $55,000, you only count the first $7,000.

Step 2: Apply the Gross Rate

Multiply the taxable wages by 6.0%.

Example: $7,000 × 0.06 = $420

Step 3: Apply the State Tax Credit

If you’ve paid your state unemployment taxes on time and your state isn’t in a credit reduction status, subtract the 5.4% credit.

Example: $7,000 × 0.054 = $378 credit

Step 4: Calculate Net FUTA Tax

Subtract the credit from the gross amount.

Example: $420 – $378 = $42 per employee

A Real-World Scenario

Take Sarah, who runs a marketing agency with 12 full-time employees. All of them earn well above the $7,000 wage base. Sarah operates in Texas, which isn’t a credit reduction state, and she pays her SUTA on time.

Her annual FUTA obligation: 12 employees × $42 = $504 total. She deposits this quarterly using IRS Form 940.

Now compare that to Marcus, who runs a staffing company in a credit reduction state. His effective FUTA rate is 0.9% instead of 0.6%. For his 200 employees, that’s $12,600 versus $8,400 — a $4,200 difference that directly impacts his bottom line.

Managing payroll taxes across multiple states? Remote People handles FUTA, SUTA, and all employment tax filings for your distributed workforce. See how it works →

FUTA Credit Reduction States

This is where FUTA gets tricky for multi-state employers.

When a state borrows money from the federal government to pay unemployment benefits and doesn’t repay the loan within two years, it becomes a “credit reduction state.” Employers in those states receive a smaller FUTA credit, which means they pay a higher effective FUTA rate.

How Credit Reduction Works

The standard FUTA credit is 5.4%. In a credit reduction state, this credit decreases by 0.3% for each year the state’s loan remains unpaid. So:

• Year 1 of credit reduction: Credit drops to 5.1%, effective rate becomes 0.9%
• Year 2: Credit drops to 4.8%, effective rate becomes 1.2%
• Year 3: Credit drops to 4.5%, effective rate becomes 1.5%

This can escalate quickly. The IRS publishes a list of credit reduction states annually, typically in November. Employers find out their additional FUTA liability when they file Form 940 in January.

Why This Matters for Remote Teams

If you’re hiring employees across multiple states, you need to track which states are in credit reduction status. An employee based in a credit reduction state costs you more in FUTA taxes than an identical employee in a state with a healthy unemployment fund.

This is one of the hidden compliance complexities that catches growing companies off guard — especially those building distributed teams across state lines.

Filing and Payment Requirements

FUTA tax is reported annually on IRS Form 940 (Employer’s Annual Federal Unemployment Tax Return), due by January 31 of the following year.

However, you may need to make quarterly deposits throughout the year.

Quarterly Deposit Rules

If your FUTA tax liability exceeds $500 in any quarter, you must deposit the tax by the last day of the month following the end of that quarter:

• Q1 (Jan–Mar): Deposit by April 30
• Q2 (Apr–Jun): Deposit by July 31
• Q3 (Jul–Sep): Deposit by October 31
• Q4 (Oct–Dec): Deposit by January 31 (with Form 940)

If your liability is $500 or less in a quarter, you can carry it forward to the next quarter. Deposits must be made electronically through the Electronic Federal Tax Payment System (EFTPS).

Penalties for Late Filing or Payment

The IRS doesn’t take FUTA compliance lightly. Late deposits can result in penalties ranging from 2% to 15% of the unpaid tax, depending on how late the payment is. Late filing of Form 940 carries an additional penalty of 5% per month on unpaid tax, up to 25%.

Common FUTA Exemptions

Not all payments to workers are subject to FUTA. The following are exempt:

• Wages paid to independent contractors — only W-2 employees count
• Family employment — wages paid to a spouse, a child under 21 working for a parent, or a parent working for a child
• Certain nonprofit organizations — 501(c)(3) organizations are exempt from FUTA
• State and local government employers — not subject to FUTA
• Certain fringe benefits — employer contributions to qualified retirement plans, group-term life insurance, and dependent care assistance (up to limits)

Understanding these exemptions matters, particularly if your workforce includes a mix of employees and contractors. Misclassifying workers can lead to unexpected FUTA liability — and penalties.

If you’re unsure about worker classification, it’s worth getting it right before tax season.

FUTA and International Employers

Here’s where it gets interesting for companies with a global presence. FUTA generally applies to wages paid to employees working in the United States. But the rules around international employment aren’t always straightforward.

If you’re a U.S. company with employees working abroad, those wages may or may not be subject to FUTA depending on the totalization agreements between the U.S. and the employee’s country of residence.

For foreign companies hiring U.S.-based employees, FUTA applies just like it would for any domestic employer. This is one of the reasons many international companies use an Employer of Record (EOR) service — to handle FUTA and other U.S. employment tax obligations without setting up a local entity.

Hiring in the U.S. without a local entity? Remote People acts as your Employer of Record, handling FUTA, SUTA, and all federal and state tax obligations. Learn more →

Key Takeaways

FUTA is one of those payroll taxes that’s easy to overlook but impossible to ignore. Here’s what every employer should remember:

• FUTA is employer-paid only — your employees never contribute to this tax
• The effective rate is usually 0.6% on the first $7,000 per employee, thanks to the state tax credit
• Maximum cost per employee is $42/year (or more in credit reduction states)
• Quarterly deposits are required when your liability exceeds $500
• Multi-state employers need to watch credit reduction states — they directly increase your FUTA costs
• Misclassifying workers as contractors when they should be employees can trigger back taxes and penalties

Getting FUTA right is part of getting payroll right. And if you’re scaling a team across states or countries, the compliance complexity multiplies fast.

Remote People simplifies all of this. From FUTA filings to multi-state payroll to international hiring, we handle the tax compliance so you can focus on building your team. Get started today →