What is FUTA – Federal Unemployment Tax Act

The Federal Unemployment Tax Act (or FUTA) is a United States federal law that imposes a federal employer tax used to help fund state workforce agencies. Employers report this tax by filing an annual Form 940 with the Internal Revenue Service. In some cases, the employer is required to pay the tax in installments during the tax year.

FUTA covers a federal share of the costs of administering the unemployment insurance (UI) and job service programs in every state. In addition, FUTA pays one-half of the cost of extended unemployment benefits (during periods of high unemployment) and provides for a fund from which states may borrow, if necessary, to pay benefits.

How FUTA Tax influence California Employers

A good example is to consider what happened during the recession that started in 2008.

As a direct result of this recession, the unemployment rate in California rose dramatically as jobs became scarce. In June 2008, when the unemployment rate was at 5.6%, Congress approved a 13-week extension. As the recession deepened, Congress passed additional expansions.

At its peak, California had offered 63 weeks of unemployment benefits. Those extensions ended on December 28, 2013.  However, beginning in January 2009, California began borrowing to cover the shortfall on its regular 26 weeks of benefits as well as for the additional 37 weeks being provided.

These funds came from the Federal Unemployment Account (FUA) which serves as a loan fund for state unemployment programs to ensure a continued flow of benefits during times of economic downturn.  As of December 13, 2016 the remaining loan balance for the state of California was $3,671,240,340, which is substantially less than the $5 billion it was forecast to be at in Q4 2016.

Employers in California have been bearing the brunt of the indebtedness of the state to the federal government for additional unemployment insurance (UI) funding since 2009.

The FUTA tax levies a federal tax on employers covered by a state’s Unemployment Insurance (UI) program. The standard FUTA tax rate is 6.0 percent on the first $7,000 of wages that are subject to FUTA. The funds from this FUTA tax create what is known as the Federal Unemployment Trust Fund, which is administered by the United States Department of Labor, or DOL.

Generally, employers may receive a credit of 5.4% when they file their Form 940 to result in a net FUTA tax rate of 0.6 percent, or 6.0 percent tax rate less the 5.4 percent credit. However, when a state’s own UI funds are depleted, the state can borrow from the Federal Unemployment Account (FUA), and if such loans are not repaid within two years that state is designated as a “credit reduction state”.

This means that part of the 5.4% FUTA tax credit is reduced, thereby increasing the effective FUTA tax rate in affected states. When this “credit reduction” is applied, the FUTA tax typically increases by 0.3%, or $21 per employee. The tax credit continues to be reduced annually by 0.3% until loans are repaid.

The impact on California employers from the FUTA credit reduction has been $292.5 million for 2012, $606.2 million for 2013 and $947.1 million for 2014. Additional FUTA credit reduction collection amounts of $1.3 billion for 2015 and $1.7 billion for 2016 are expected.

Without any change in the state’s UI funding by the State Legislature, FUTA costs for California employers are anticipated to increase by an additional 0.3 percent each year until the UI Trust Fund regains solvency.

FUTA Credit Reduction Rates – An Ongoing Problem for California Employers

California has had an outstanding FUTA debt since 2010. The state has been subject to a special “Benefit Cost Ratio (BCR)” add-on tax of 1.5% beginning in 2014. California’s effective FUTA rate already increased from 1.5% to 1.8% due to the credit reduction for 2016.

Fortunately, the state submitted an application requesting a waiver for the BCR add-on which was once again granted. But this process will need to be repeated each year going forward until the loan balance is repaid. The combination of credit reduction and BCR would have resulted in a five-fold increase over the normal FUTA tax rate.

Employers in California accrue and pay at the normal 0.6% rate during the calendar year. The additional amount of 1.8% will be added for a total FUTA Tax rate of 2.4%. This is due in January 2017 for tax year 2016. Employers report this tax by filing an annual Form 940 with the Internal Revenue Service. In some cases, the employer is required to pay the tax in installments during the tax year.

For California employers, the costly prospect of ongoing and increasing FUTA tax rates remains. The projection of increases through 2018 is also a sobering reminder of the fiscal state of California.

By 2018, the year that the state’s UI fund loan should be repaid in full, employers can expect to pay an additional $2.3 billion in federal employment taxes. California’s UI fund will then be “in the black”, and the state can begin to build a reserve. This reserve will be depleted again, however, when the next recession hits California, unless changes are made to California’s UI financing structure.

Get in touch with us anytime to learn more about FUTA Tax in San Francisco, CA.

FUTA Tax Credit Reduction Calculation

futa tax credit reduction calculation
Planning for Future FUTA Credit Reduction Rate Increases

Though employers and business owners can do little to affect the outcome of state legislative actions they can do a great deal to anticipate and prepare for projected increases in FUTA tax costs. While budgets and fiscal plans should already incorporate FUTA and other taxes, knowing that these in particular are certainly going to increase allow employers to adjust and plan accordingly.

Looking at “best case” scenario, a simple formula would be to add an additional $21 for each employee earning at least $7,000 in 2017. If you employ 50 people, and they all earn in excess of $7,000 per year that would be an increase of $1,050 in your payroll budget. For employers with 500 or more employees, this can still represent an additional $10,500 and more above what they had to pay for tax year 2017.

While the additional penalty of the “Benefit Cost Ratio (BCR)” add-on tax has not yet been imposed, it would be prudent to plan for that possibility – “worst case” scenario. At the very least you will have the funds to cover it and if it is not required, you will have a surplus to carry over for tax year 2017 when the next FUTA credit reduction takes effect.

To help employers determine the estimated effect of these FUTA tax increases Accuchex has developed an online FUTA Tax calculator. Please follow the link below to calculate your organization’s estimated FUTA Tax for 2016:

Calculate the possible impact of the 2016 FUTA rate with the Accuchex Online FUTA Calculator