Understanding the FUTA Tax

The Federal Unemployment Tax Act (FUTA) is a payroll tax for employers that covers a percentage of employee wages. By paying into the unemployment tax pool, state and federal governments can provide benefits to people who have been laid off or furloughed from their jobs. 

In times of high unemployment, like during the COVID-19 pandemic, governing bodies rely on local businesses to pay into FUTA so out-of-work Americans can cover basic expenses while they find new jobs. 

FUTA may be colloquially known as “employment tax” or simply as “unemployment.” Identifying both terms can help you to label the tax clearly on your balance sheet. 

Understanding FUTA and how to pay into it can help you to budget your operating expenses for the year—especially if you plan to hire employees. Keep reading to answer all of your questions about the FUTA tax.   

Who Pays FUTA Tax?

To better understand FUTA, it helps to look at who pays into it. Employers pay FUTA tax if they have at least 1 employee who works 20 hours per week or if they have paid at least 1 employee $1,500 in any quarter. 

Employees do not pay into FUTA, and you may not pull FUTA from the income of your team members as their employer. This tax is different from Social Security and Medicare, which your employees are expected to pay into. You can define FUTA by the employer’s burden to the state to support unemployed residents.  

There are some exemptions for organizations that do not need to pay into FUTA. Nonprofits that operate under a 501(c)3 status do not need to pay employment taxes. However, other nonprofits, like those that operate as foundations, may still be subject to FUTA guidelines. 

Is FUTA Tax Paid Quarterly?

Yes, FUTA payments are due quarterly, starting on April 30 and ending on January 31. However, if your FUTA requirements are less than $500, you can carry the payment over to the next quarter. You’re allowed to keep rolling your FUTA payments until you exceed $500, at which point they become due that quarter. 

Tracking how much you pay your team members and their FUTA tax is important for determining whether you owe taxes or not that quarter. If you fail to pay into FUTA on time, you could receive penalties from the IRS ranging from 2–15% of what you owe.

While employers pay into FUTA quarterly, they’re also required to fill out Form 940 annually to report how much their employees earned and what they paid in FUTA taxes. If you file all of your FUTA taxes on the day they’re due (January 31), then you have until February 10 to submit your Form 940. If this date falls on a Saturday or Sunday, you’ll have until the next business day.  

Do LLC Owners Have to Pay Unemployment Tax?

Limited liability corporations (LLCs) may or may not be required to pay into FUTA depending on the structure of the business. A sole proprietor or owner can operate under an LLC and won’t have to issue a W-2 if they work alone. However, if that business owner takes on an employee and provides them with a W-2, then the owner will need to pay into FUTA. 

FUTA also has guidelines for family-owned businesses that operate as LLCs. For example, wages paid to children when a parent—or both parents—own the LLC are not subject to FUTA. Wages paid to a parent are also not subject to FUTA. 

What’s the FUTA Limit for 2020?

The FUTA tax rate for 2020 is 6% on the first $7,000 an employee earns. Anything above the first $7,000 isn’t taxed. For example, to do a quick FUTA calculation: it doesn’t matter whether an employee’s salary is set at $30,000 or $70,000, an employer would only pay $420 on their earnings. 

Small business owners who pay into state unemployment (SUTA—the State Unemployment Tax Act) are eligible for a tax credit of up to 5.4%. This means that you’ll only need to pay 0.6% of FUTA once you’ve paid into state unemployment funds. 

By paying the FUTA rate on a per-employee basis, an employer pays their fair share based on their size. This prevents an undue burden on smaller businesses that couldn’t afford to pay the same tax rate as larger organizations. 

Learn to Budget for Your Tax Expenses

Understanding the different federal taxes that you need to pay helps you to set an operating budget as a business owner and gives you an idea of whether or not you can afford to hire an employee—or multiple employees. 

At Lendio, we can help you to access the funding you need to grow your business and cover these operating costs so you aren’t held back by the costs of hiring valuable workers. Learn more about our loan options to help you get your business started.