If you own a small business and have employees, then you are familiar with the Federal Unemployment Tax Act (FUTA) and the tax that employers pay that helps to fund the Federal Unemployment Trust Fund. The trust fund helps to cover a portion of the costs of administering the unemployment insurance programs in every state and pays one half of the cost of extended unemployment benefits. Most employers pay both a federal and a state tax. And only employers pay this tax; there is no deduction from employee wages for any portion of the tax.
A FUTA Tax Overview
The current FUTA rate is 6% on the first $7000 of wages paid to every employee. However, because most businesses also pay unemployment taxes to their home state, the federal government allows a credit of up to 5.4% so that employers are not excessively over taxed. This means that the FUTA tax rate is 0.6% for most employers.
But what you may not be familiar with is that states can borrow money from the trust fund to help pay unemployment compensation benefits when their own funds are limited. States are, of course, required to pay this money back. But if they are unable to, the Social Security Act allows the federal government to recover the money directly from employers by reducing the FUTA credit that it gives to employers.
FUTA Tax Credit Reduction
FUTA sections 3302(c)(2) and 33002(d)(3) provide that employers in states that have a balance due on January 1 of two or more consecutive years, are subject to a reduction in credits otherwise available against FUTA tax if all advances are not repaid before November 10 of the taxable year. These credit reductions are taken against the regular credit of 5.4%.
Simply put, a state that has not repaid money it borrowed from the federal government to pay unemployment benefits is a “credit reduction state.” If an employer pays wages that are subject to the unemployment tax laws of a credit reduction state, then that employer must pay additional federal unemployment tax when filing its Form 940 for the tax year.
States That are Affected
For 2014, there were fifteen states that faced having a credit reduction. But of those, eight were able to pay their loans back in full. Therefore, only seven states will be subject to credit reductions for 2014 taxes. So while employers in states without a credit reduction will have a FUTA tax rate of 0.6%, employers in these seven states will pay a much higher tax. The seven states and their FUTA credit reduction amounts are listed below:
| STATE | CREDIT REDUCTION |
| California | 1.8% |
| Connecticut | 2.3% |
| Indiana | 2.1% |
| Kentucky | 1.8% |
| New York | 1.8% |
| North Carolina | 1.8% |
| Ohio | 1.8% |
Based on the table, if you are an employer in California, instead of being able to take a credit of 5.4% on your FUTA taxes, your credit amount will only be 3.6%. That means you will pay a FUTA tax rate of 2.4% instead of .6%. It may not sound like much, but for an employer with 8 employees, that amounts to just over an additional $1000 for the year. In Connecticut, the additional tax for 8 employees amounts to almost $1300. That could be a lot for some small businesses that aren’t prepared for it. If you employee 24 people in Indiana, the additional tax would be approximately $3500. Forty employees, over $5800.
Be Prepared
Unfortunately, if your small business is located in one of these seven states, the only thing you can do is be aware of the additional tax and budget for it. The increased FUTA tax is considered to be incurred in the fourth quarter of the year and is therefore due at the same time as the fourth quarter FUTA tax is regularly due; for 2014 taxes that is January 31, 2015. The additional tax is calculated and reported on Form 940, Employer’s Annual Federal Unemployment Tax Return.