When employees lose their jobs through no fault of their own, typically they file for unemployment compensation from their state to ensure that they continue to earn at least a portion of their income while they find a new job. The funds for this compensation come from employers themselves, who pay both federal and state unemployment taxes on their employees’ earnings.
Unemployment taxes are paid under the rules established by the Federal Unemployment Tax Act, or FUTA. States also require companies to pay unemployment taxes in addition to the federal requirements; in some cases, the state rules are actually different from, and supersede, the federal rules. In most cases, employers are responsible for paying the entire unemployment tax bill, and do not withhold the tax from employee pay.
The first step in calculating your FUTA tax is to determine if you actually have to pay the tax, as some businesses are exempt. The IRS has a two-factor test for determining FUTA obligations. Your company only has to meet one of these qualifications in a calendar year in order to have to pay FUTA taxes:
If either of these qualifications apply to your business, then you must pay unemployment tax for the current calendar year and the following calendar year. That being said, in some states certain businesses are exempt from paying unemployment taxes, and organizations with 501(c) 3 status are also exempt. In addition, you do not have to pay unemployment taxes if you hire your parent or spouse, or your child if he or she is under age 21. Check with your payroll processing company or your state department of labor to determine if your business is exempt from the tax.
Determining your FUTA tax bill can be complex, since most businesses receive credits for the amount that they pay for their state unemployment taxes. Currently, the federal unemployment tax rate is 6 percent, paid only on the wage base, which is the first $7,000 the employee earns in the calendar year. However, most employers receive a credit of 5.4 percent for the state unemployment taxes they pay, making the effective tax rate .6 percent. This works out to a maximum FUTA bill of $42 per employee, per quarter. Some states, though, are considered “credit reduction” states. This means that the state borrowed money from the federal government to cover unemployment benefits, but has not repaid that money within two years. The result is that the credit reduction applies to all employers in that state.
However, state tax rates vary considerably, and the wage base thresholds are generally much higher. In Wisconsin, for example, the maximum state unemployment tax rate is 12 percent, with a wage base of $14,000; in Washington, the maximum rate is only 5.7 percent, but applies to a wage base of $45,000. Not all businesses pay the maximum rates, and a number of factors go into determining the actual rate for a specific business, but these taxes are paid in addition to the federal tax bill. Most states also have a “new employer” rate. This is a flat tax rate charged to employers who have only recently hired employees, and remains applicable until the employer has established “experience” with the state.
In some states, including Alaska, New Jersey, and Pennsylvania, employees are responsible for paying the state unemployment taxes, and as an employer, you are responsible for withholding the taxes and paying them on behalf of the employee. And if you have employees in multiple states — for instance, someone lives in Maryland but works in Virginia — you need to pay state unemployment taxes to both states.
Employers are required to submit unemployment tax payments quarterly, typically within 30 days of the last day of each quarter, if they owe more than $500. When the business files its annual tax return, it will submit Form 940 indicating how much has been paid thus far, as well as the remaining payment for the any amount owed.
If your business owes less than $500, then the tax obligation carries over to the next quarter. If you do not reach $500 during the calendar year, then you will pay the balance when you file your annual tax return. Keep in mind that state procedures may differ, so be sure to check with your state department of labor to determine payment policies and due dates. Failing to pay unemployment taxes when they are due can lead to significant penalties and interest.
The complexity of handling all aspects of your company’s payroll can lead to costly errors, missed deadlines, and other issues. Working with a payroll company like National PEO can help ensure everything is handled properly and your business stays on track.Back to blog list