Understanding More About Federal Unemployment Tax Liability

State and Federal Unemployment Tax

Unemployment insurance (UI) benefits are paid to workers when they lose their jobs, but employers are the ones who actually fund the UI benefit programs. Each state operates its own unemployment compensation program that is funded largely by employer’s taxes, so you should expect to pay state unemployment insurance taxes in addition to any federal unemployment tax you may owe.

The levels of tax liability can depend on a variety of factors:

•         The amounts employers pay their employees
•         The number of unemployment claims filed against the business
•         The success that the employer has in challenging unwarranted claims in a timely manner

Most states do not allow employers to withhold UI taxes from their employees’ payroll. But if you have employees in Alaska, New Jersey, or Pennsylvania, you will withhold unemployment taxes from your employees’ wages because these states assess a small UI tax on employees in addition to the tax imposed on the employer.

Federal Unemployment Tax Liability

The Federal Unemployment Tax Act (FUTA) imposes a payroll tax on employers, based on the wages they pay to their employees. Businesses must pay the FUTA tax on its own, not withhold it from employee wages.

Your business must pay FUTA tax if during the current or the preceding calendar year you meet either of the following tests:

•         Test #1:  You pay wages totaling at least $1,500 to your employees in any calendar quarter
•         Test #2:  You have at least one employee on any given day in each of 20 different calendar weeks (the 20 weeks need not be consecutive, the “one employee” need not be the same individual and a “calendar week” is a period of seven successive days beginning with Sunday and ending the following Saturday)

If you meet either of the tests above, you are liable for the FUTA federal unemployment tax for the entire calendar year and for the next year as well.

You will be allowed to claim credits against your gross FUTA tax if you paid all your state unemployment taxes on time, and before the due date of your FUTA tax return. If for some reason, you cannot pay your state taxes by the federal return due date, you may be able to get a filing extension. This extension may preserve your right to get the maximum allowable credit.

It is also important to note that not for profit 501(c)(3) organizations are exempt from the FUTA tax.

Computing Your State Unemployment Tax Liability

In order to calculate what you owe in state unemployment taxes, you must multiply the wages you pay each of your employees by your tax rate. Each state limits the taxes you pay for one employee by specifying a maximum wage amount to which the tax applies.  

For the first $7,000 of wages you pay your employees, FUTA tax is imposed at a single flat rate of 0.6%. After the first $7,000 an employee earns, you have no further FUTA liability for that employee for the year. Once an employee’s wages for the calendar year exceed that state’s maximum amount, your state tax liability ends for that employee.

Employer Tax Rates

Every year, state unemployment tax rates are assigned to each individual employer. Each state uses an experience-rating system to determine an employer’s tax rate for the year. State rating systems tend to vary in the way they are facilitated. You can see our tax consulting services page for further information on this.

The goal of these ratings is to help the states assign tax rates. Typically, the rating systems will assign:

•         Lower tax rates to employers whose workers would suffer the least involuntary unemployment
•         Higher tax rates to employers whose workers suffer the most involuntary unemployment

If your business is new and you’ve just hired your employees, you’ll pay a fixed rate tax until you’ve contributed to the state’s unemployment compensation program for 1-3 years depending on the state.