What is FUTA?

Like individuals, employers need to comply with local, state, and federal payroll tax regulations, including FUTA, the State Unemployment Tax Act (SUTA), the Federal Insurance Contributions Act (FICA), and others. Employers need to accurately calculate these taxes and file returns on time to avoid facing hefty penalties.

But in reality, it’s payroll providers who are responsible for ensuring employers aren't placed in this challenging position.

If you’re a payroll provider, you know the responsibility can be daunting. And even if you use a third-party solution like Symmetry to ensure compliance and handle payroll tax calculations, you need some knowledge of these laws to truly do right by your customers. 

That’s because white-glove service means going the extra mile to educate and guide your customers through their questions and concerns, and it’s what will set you apart from your competition. To help you out, this article covers everything you need to know about one payroll tax law in particular: FUTA.

How does FUTA work?

Employers who pay wages of $1,500 or more are required to report and make quarterly payments toward FUTA taxes. Typically, this tax rate is 6% of the first $7,000 of an employee's wages or annual salary. 

Generally, if you pay into state unemployment funds, you may receive a credit of up to 5.4% of FUTA taxable wages when you file your Form 940. If you qualify for this maximum credit, your FUTA tax rate after the credit is 0.6%. That said, to be eligible for the maximum credit, you have to:

• Pay your state unemployment taxes in full 
• Pay your state unemployment taxes by the due date of your Form 940
• Pay your state unemployment taxes on all the same wages subject to FUTA tax, and
• Ensure your state is not classified as a credit reduction state.

As you can see, FUTA taxes can be complex. That’s why it’s absolutely essential for payroll providers to accurately apply the correct FUTA rate for each employer they serve.

Exemptions to FUTA

Notably, there are some exemptions to FUTA taxes, including religious organizations, government entities, charitable nonprofits, educational institutions, railroad companies and workers, household employees, and independent contractors. By accurately applying these exemptions, payroll providers can help minimize FUTA tax liability—and it's your role to guide them through this process.

Notably, railroad companies and workers are exempt from FUTA. This means railroad companies don’t have to pay FUTA taxes, and their workers aren’t eligible for federal unemployment benefits. However, they might still be subject to other industry-specific tax regulations and benefits, like the Railroad Retirement Tax Act (RRTA) and the Railroad Unemployment Insurance Act (RUIA). 

FUTA tax credit reductions

But there’s more. Employers can also receive a credit of up to 5.4% against FUTA tax. Essentially, when an employer has paid state unemployment taxes (or SUTA tax), that amount can be deducted from the employer’s federal income taxes to claim as a credit (maximum of $42 per employee each year). Effectively, this credit lowers the FUTA tax rate to 0.6%.

However, if the state doesn’t have enough balance in its unemployment trust fund and needs to borrow funds from the federal government—known as a credit reduction state—this credit can be reduced. To put it more clearly, the FUTA tax rate can go up, passing on the responsibility of filling the state’s fund to employers.

Specifically, under Sections 3302(c)(2) and 3302(d)(3) of FUTA, employers in states with unpaid federal loans for unemployment funds for two consecutive years at the start of January 1 will face reduced credits against their FUTA taxes. This applies if the loans are not fully repaid by November 10 of the tax year. 

For instance, according to the US Department of Labor, the following states had a Social Security Act Title XII—which covers advances to state unemployment funds—balance as of January 1, 2024. If these states do not repay the outstanding advance by November 10, 2024, employers in these states could face a reduction in FUTA credit on their IRS Form 940:

As a payroll provider, you should at least withhold the standard after-credit FUTA tax rate of 0.6% for all customers. Then, if your customer is subject to a credit reduction because they are in a state with an unpaid loan (this may include California, Connecticut, New York, and the U.S. Virgin Islands in 2024), you can help them account for the credit reduction on their Schedule A (Form 940). The credit reduction amount will then be due with the employer’s fourth quarter deposit.

What’s the impact of FUTA tax on payroll and people tech providers?

It’s simple, really: Like any payroll tax, the importance of FUTA comes down to compliance. As a people tech or payroll provider, you must accurately calculate FUTA taxes for your customers and possibly help them file Form 940 annually in their tax returns.

If you get this wrong, your customers will face penalties, which, in turn, will shake their confidence and trust in your platform. Here’s what the IRS has to say about federal taxes, including FUTA:

“Even though the employer may forward the tax amounts to the third-party to make the tax deposits, the employer is the responsible party. If the third-party fails to make the federal tax payments, the IRS may assess penalties and interest on the employer's account. The employer is liable for all taxes, penalties and interest due. The employer may also be held personally liable for certain unpaid federal taxes.”

In other words, if the employer doesn't pay this on time or properly, they will face the “Failure to Deposit Penalty,” which can be anywhere between 2% and 15% of the unpaid deposit, along with any additional penalties for incorrect calculations. 

That being said, as a payroll provider, your role is not just to ensure customers’ compliance with these federal requirements, but also to educate them on tax rates, updates, exemptions, and the impact of other variables to minimize your customers’ FUTA tax costs—that’s how you win their trust and gain a competitive edge.

Get FUTA and other payroll tax calculations right

As you’ve learned by now, payroll taxes—including FUTA—are a lot to keep track of. Plus, compliance is complicated, especially when you’re dealing with multiple states. Luckily, Symmetry can simplify this process for you. 

Industry-leading people tech providers like Gusto and UKG build their payroll products on Symmetry’s tax compliance infrastructure. We handle the heavy lifting of keeping up with all tax updates, auditing calculations for compliance, and supporting you throughout the process, so you can focus on creating a remarkable platform and winning more customers.