What is Futa Tax?

Explanation

Federal Unemployment Tax Act is basically a variant of payroll taxPayroll TaxPayroll taxes are statutory deductions made by the employer from an employee’s regular salary and wages, and usually, such withholdings mostly have both employer and employee equal contributions. These taxes are collected by tax authorities from respective employers and paid for human welfare schemes, infrastructure development.read more wherein the government collects taxes from the business that has employees. The main intent behind this revenue collection is to allocate the collected amount under the state unemployment agencies who then pay money to those workers that are unemployed and are eligible to take up insurance on unemployment. It is collected under the legislation of this tax act that mandates business and employers to file internal revenue service Form 940 on a yearly basis in line with the paying up for this payroll tax.

The federal unemployment tax is basically a provision of the federal type whose broad intent is towards the regulation of the cost allocationCost AllocationCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more, which in turn is then utilized to monitor and administer job service programs and unemployment insurance. As per the directives of this act, the employers are mandated to submit state and federal unemployment taxes that are then utilized effectively to finance the accounts of unemployment of the federal government.

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Federal Unemployment Tax Act Process

  • The employer determines an effective percentage over the whole employee’s wages.Basis the percentage determined; the employers submit taxes to the government.The employees are not required to deduct any amount out of their income for this tax.The employer has to ensure that it pays such taxes on both state and federal levels.The employers are therefore mandated to file Form 940 on an annual basis that lists down the amount paid as the FUTA tax.The amount deposited is collected in a federal government fund.The fund is then utilized to compensate employees who have been laid-off and are currently unemployed and at the same time qualify for unemployment insurance.

Paying FUTA Taxes to IRS

  • The internal revenue service is authorized to tax collection agencies under Congress, and it has the critical role of monitoring the internal revenue code as formulated by Congress.The employer, therefore, should determine the FUTA tax liability for each and every payroll he is maintaining.The employer has to keep the provision and set aside some amount that equals the FUTA tax liability.The employer has to make periodic payments to the internal revenue service and that it has to be further supplemented by the submission of an annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more by filing Form 940.Form 940 is federal unemployment tax returns to be filled by the employer.

Who should pay FUTA Tax?

  • The internal revenue service lists down three basic tests for the business to determine whether they should pay FUTA tax or not.As per the first test, the employer has to check whether he is paying wages of $1,500 or higher to their employees for any financial year.The business should have one or more than one employee for any financial or calendar quarter.Lastly, in order to be eligible for this tax, the business has to determine the full time, part-time, and temporary employees’ basis their involvement during the course of the day in 20 or more weeks.However, it should be noted that wages, as compensated by the employer to the spouse of employees and for children under the age of 21, are not identified as FUTA tax.

FUTA Tax Rate

The current FUTA tax rate is 6 percent. The tax is applied to the Federal or FUTA wage base. The current Federal or FUTA base wage is $7,000. Therefore, the tax is applicable to the first $7,000 that is compensated towards the wages of each hired employee for a calendar year.

FUTA Tax Credit

The employer receives FUTA tax credit of 5.4 percent if he has made payments to state unemployment taxes in a timely manner. The following information is to be disclosed in form 940, which is to be submitted to the internal revenue service. IF the service finds that the business is entitled to full credit of 5.4 percent, the IRS revises the tax rate to 0.6 percent. However, the state should not be under a credit reduction state. A state is said to be a credit reduction state if the state had borrowed funds from the federal government to finance the unemployment benefits but has failed to repay back. Therefore, if the employer pays for state unemployment tax for a credit reduction state, the employer won’t receive any credit; rather, the employer would be subject to a greater amount of FUTA tax.

Benefits

This tax collected by the internal revenue service is used to finance the job service programs. It is additionally used to make premiums on the unemployment insurance scheme. This ensures that the unemployed labor workforce is benefited until the time they find a new job for themselves. The benefits are specifically paid to those employees who have been laid off due to reasons other than gross misconduct or due to recession. It focuses on financial support for unemployed skilled workers. An employer also enjoys the benefits of FUTA credit if he makes payment to states’ unemployment taxes, which are not under credit reduction. There are also incentives for making timely tax payments in the form of a tax credit. The employees are never subjected to taxes, and such taxes have to be entirely borne by the employers themselves.

Conclusion

The Federal unemployment tax act is legislation passed by the Federal government wherein all employers have to pay taxes on wages they pay to employees. The amount collected is utilized for financing job service programs for every state and administers the unemployment insurance scheme for the eligible population of the unemployed workforce. As of the calendar year 2020, the applicable FUTA tax rate is at 6 percent that is levied on the first $7,000, and such payments are done on an annual basis.

This has been a guide to what is Futa Tax and its Definition. Here we discuss the process and Who should pay such a tax along with its rate and benefits. You may learn more about financing from the following articles –

  • Unemployment Rate FormulaUnemployment CompensationUnderemploymentStructural Unemployment