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HOME > ARTICLES > FEDERAL AND STATE UNEMPLOYMENT INSURANCE > FEDERAL UNEMPLOYMENT INSURANCE

Payroll Articles
Federal Unemployment Insurance

To provide income for terminated Employees while they are trying to secure another job, a joint federal- state system of unemployment insurance has evolved. These programs are funded by employer contributions on both the federal and state levels. Federal unemployment taxes are used to help fund the various unemployment insurance programs developed by the states. Each of the states also requires employers to contribute toward its unemployment insurance program in the form of state unemployment taxes.

Federal Unemployment Insurance

On the federal level, employer contributions in the form of unemployment taxes are required by the Federal Unemployment Tax Act (FUTA). The FUTA tax is paid only by employers and is calculated as a percentage of covered wages for each Employee. FUTA taxes cannot be withheld from Employees'   wages. Several states require Employee contributions but most follow the federal method.

Who Must Pay FUTA Tax

Employers meeting one of the following criteria must pay federal unemployment tax:

What Wages Are Exempt From FUTA

Details on whether certain payments to Employees are wages for FUTA purposes are discussed later. In general, all Employee compensation is subject to FUTA tax unless specifically exempted under the Internal Revenue Code. Following is a list of several exempt payments:

What Types of Employment Are Exempt From FUTA

Certain types of employment are also exempt from FUTA. Here is a list of some of them:

FUTA Tax Rate and Wage Base

Through 2007, employers pay FUTA tax on their Employees' wages at the rate of 6.2%, which includes a permanent rate of 6.0% and a surtax of 0.2%. The rate is applied to the first $7,000 of an Employee's covered wages in a calendar year. But most employers do not pay the full 6.2%. If they pay their state unemployment taxes in full and on time, employers can receive a credit against their FUTA tax rate of up to 5.4%. Employers receiving the full credit have an effective FUTA tax rate of 0.8% and pay $56 for each Employee receiving at least $7,000 of covered wages ($7,000 x .008 = $56). The FUTA surtax was extended through 2007 by the Taxpayer Relief Act of 1997. Constructive payment rules apply. As with federal income, Social Security, and Medicare taxes, FUTA tax applies only to wages when they are actually or constructively paid, not when earned. This can be important for wages earned at the end of one year, after an Employee has surpassed the FUTA wage base, but paid in the next year. If the Employee does not have access to the wages until the next year, the employer must pay FUTA tax based on those wages up to the $7,000 wage base. Employees working for more than one employer. Similar to Social Security and Medicare taxes, if an Employee works for more than one employer, the wage limit must be applied to the wages paid by each employer. The wages may not be aggregated by the employers in determining whether the wage limit was reached.

Successor employers

The rules allowing successor employers to consider the wages paid to an Employee by a predecessor company when determining if the wage base for Social Security tax has been reached also apply to the FUTA tax wage base. In addition, both the predecessor and the successor must be covered employers under FUTA for the exception to apply. A successor employer must have acquired the property or the predecessor company. The Employee must have been employed immediately before and after succession by the predecessor and the successor. The wages must have been paid by the predecessor during the calender year of the acquisition.

Common Paymaster

The rules allowing related corporations to combine wages paid to concurrently employed Employees by a Common Paymaster when determining if the Social Security wage base has been met also apply to the FUTA tax wage base.

Depositing and Paying FUTA Tax

Employers must determine their FUTA tax liability on a quarterly basis. In doing so, they can assume they will be entitled to the full 5.4% credit for state unemployment insurance contributions, at least for the first three calendar quarters of the year. Therefore, employers calculate their FUTA liability by multiplying their FUTA taxable wages for the quarter by 0.8%: taxable wages for quarter x .008 = quarterly FUTA liability

The amount of the employer's quarterly FUTA liability for the first three quarters of the year determines how the employer deposits the tax owed. In each of the first three quarters, if the employer owes more than $100, the full amount must be deposited by the last day of the month following the end of the quarter. The deposit dates are:
first quarter ends March 31 ..........Deposit due April 30
Second quarter ends June 30...........Deposit due July 31
Third quarter ends September 30 ......Deposit due October 31

EXTRA DAY FOR WEEKENDS AND HOLIDAYS

If the FUTA tax deposit due date falls on a Saturday, Sunday, or federal or state legal holiday, the deposit is due on the next business day.

Special rule for small amounts owed

No deposit is necessary when the employer's FUTA liability for a calendar quarter is $100 or less. The liability is merely carried over and added to the employer's liability for the next quarter when that quarter's liability is calculated.

Example: Ables Retail had a FUTA taxable payroll of $10,000 for the first quarter of 2004, resulting in a FUTA tax liability of $80 ($10,000 x .008). Ables was not required to make a deposit of the FUTA tax owed by April 30, 2003 because the amount of the liability did not exceed $100. For the second quarter, Ables FUTA taxable payroll was $12,000, as more Employees worked more hours. Ables second quarter FUTA tax liability was $96 ($12,000 x .008), but a deposit of $176 was necessary by July 31 because the total liability, including the first quarter liability of $80, determined the amount of FUTA tax owed.

Final quarter liability

Employers determine their fourth quarter FUTA liability when they complete Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return . In completing Form 940 (or the short form, Form 940-EZ, if applicable), the employer determines how much of the 5.4% state credit it is actually entitled to and how much its total FUTA balance for the year is. If the total balance due (after taking into account previous deposits and any undeposited amounts from prior quarters) is more than $100, the full amount owed must be deposited by January 31. If the balance due is $100 or less, payment can be attached to the employer's Form 940 or 940-EZ when the form is filed (by January 31).

de minimis deposit exemption

Under new regulations, an employer will not be required to deposit FUTA tax for a quarter if the amount of the employer's accumulated Social Security, Medicare, and withheld federal income taxes for the quarter are less than $2,500 and the employer is permitted to remit those taxes with the employers timely filed employment tax return for the quarter (i.e., if the employer is a de minimis depositor). The employer will remain subject to the FUTA deposit requirements and will be required to deposit accumulated FUTA tax for any quarter in which the amount of accumulated Social Security, Medicare, and withheld federal incomes taxes is at least $2,500 and the amount of accumulated FUTA tax exceeds $100. The proposed regulations would also permit an employer that is a de minimis depositor for the last calendar quarter of a year to remit the balance of its FUTA tax liability for the year with a timely filed return.

Calculating the State Credits Against FUTA Tax Liability

As was mentioned earlier, an employer's FUTA tax rate of 6.2% can be reduced by up to 5.4% through credits the employer can take based on the amount and timeliness of state unemployment taxes it pays. There are two types of credit against FUTA liability. The "90%" or normal. credit provides a reduction in FUTA liability for payments required and actually made under state unemployment compensation laws. The "additional" credit allows employers whose state unemployment tax rate is less than 5.4% because of a favorable unemployment history to receive credit for the difference between 5.4% and the percentage actually paid. An employer's total normal and additional credits against the FUTA tax rate of 6.2% cannot exceed 5.4%. The normal credit against FUTA tax liability equals the amount of an employer's required contributions paid timely into a certified state unemployment insurance fund. It is also called the 90% credit because the amount of the credit is limited to 90% of the basic 6.0% FUTA tax rate. Several requirements must be met before state unemployment tax payments can be credited against FUTA liability. They include: Payment must be made by Form 940 due date. To receive the full normal credit, all state unemployment taxes owed must be paid by the filing date for Form 940, January 31 (or February 10, if the employer has timely deposited its full FUTA tax liability), even if the state payment deadline is later. If an extension for filing the form is granted the employer can still receive full credit for state payments made by the extended filing date. For state unemployment taxes paid after the filing deadline, the credit is limited to 90% of the payments (full credit is allowed for whatever payments were made before the filing date). No credit is allowed for state payments made after the employer files its Form 940.

CREDIT AVAILABLE FOR PAYMENT TO WRONG STATE

If an employer makes a timely payment of state unemployment taxes but sends the payment to the wrong state by mistake, it can still receive the full normal FUTA credit even though the payment to the correct state is made after Form 940 is due.

State must have a certified unemployment insurance program

To qualify for the normal credit, the state law requiring payment of state unemployment taxes must be certified by the U.S. Department of Labor as complying with federal requirements regarding the joint federal/state unemployment insurance program. The state must also make timely payments of all interest due on loans from the federal unemployment fund. Payments required of employers by an uncertified law cannot be credited against FUTA liability.

Payments must be required by state law

Only those unemployment taxes that are required to be paid under state law can be credited against FUTA liability. Therefore, voluntary contributions allowed by some states to reduce an employer's unemployment tax rate cannot be part of the normal credit against FUTA liability. (They may, however, contribute to the additional. credit an employer gets when paying a state tax rate of less than 5.4%.) On the other hand, an employer that voluntarily chooses to participate in its state's unemployment insurance program without being required to do so receives the normal credit for timely payments it makes. The payments are considered to be required for purposes of determining the FUTA credit.

Amounts owed must actually be paid.

Required state unemployment taxes must actually be paid into the state fund in order to be eligible for the normal credit against FUTA liability. Payments made by employers that are held in separate accounts while they challenge state tax rate assessments are not credited until the rate is finally set and the payments reach the state fund.

State contributions must be paid by the employer

Several states require Employees as well as employers to make unemployment insurance contributions (Alaska, New Jersey, and Pennsylvania). Such Employee contributions may not be taken as a credit against the employer's FUTA liability. But if the employer voluntarily pays the Employees' share of state unemployment tax liability, it will receive normal credit for those payments.

NO CREDIT FOR STATE-EXEMPT EMPLOYERS

If an employer is exempt from coverage under state unemployment insurance laws in the states where it operates but is subject to FUTA, it must pay the full 6.2% FUTA tax rate. Depending on the law in individual states, however, the employer may voluntarily submit to state coverage and receive credit for payments made to the state.

Additional credit

In order to allow employers with lower unemployment tax rates (based on their more stable employment history) to receive the same credit against FUTA tax liability as other employers, these lower rate employers are granted an additional credit equal to the difference between their tax rate and 5.4%. When added to the normal credit, the total credit cannot exceed 5.4%. The availability of the additional credit does not depend on the timeliness of the employer's state tax payments.

Successor employers

Successor employers acquiring predecessor companies that are not employers under FUTA when the acquisition is made (e.g., they did not have Employees for 20 weeks during the current or preceding year) receive a FUTA tax credit for state unemployment taxes paid by the predecessor that relate to Employees who work for both the predecessor and the successor. The successor's credit equals the credit the predecessor would have been entitled to if it had been a covered employer during the year.

Credit reductions because of state loans

Under the joint federal/state unemployment insurance system, states with a high rate of unemployment and difficulty meeting their benefit obligations can borrow money from the federal unemployment insurance fund to pay benefits. If loans taken out during one year are not repaid by the end of the following calendar year, the FUTA credits for employers in those states are reduced, with the extra FUTA taxes paid being applied against each state's loan balance. A state with an outstanding loan can avoid a credit reduction for its employers by repaying the loan by November 10 of the year the reduction is scheduled to take effect. If the loan is not repaid, a credit reduction of 0.3% goes into effect, with employers in that state having their maximum credit reduced to 5.1% (5.4% - 0.3%) and their effective FUTA tax rate increased to 1.1% (0.8% + 0.3%). The more years a loan remains unpaid, the greater the credit reduction becomes, although there are limits for states that have made an effort to keep their balances in check. Figuring the reduction. Sometime after November 10 of each year, the credit reductions for that year are announced by the IRS and are included on Form 940 (Part I, Line 6) so employers in the affected states can figure the amount of their credit reduction. For 2004, there is a credit reduction in New York.

Reporting FUTA Tax on Form 940

Employers covered by FUTA must report their liability annually on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. As mentioned earlier, they may also pay their fourth quarter liability with Form 940 if the liability is $100 or less. The purpose of the form is to determine the employer's FUTA taxable wages for the calendar year and the FUTA tax liability on those wages after accounting for applicable state unemployment tax credits and FUTA tax deposits made during the year.

Can you use Form 940-EZ?

The first three items on the Form 940 (Questions A through C) are questions designed to determine if the employer is eligible to file Form 940-EZ, Employer's Annual Federal Unemployment (FUTA) Tax Return, a simplified version of Form 940. An employer is eligible to file Form 940-EZ if:

Employers in a credit reduction state cannot use Form 940-EZ. Therefore, in years where at least one state is subject to credit reduction, a fourth question is added to the items appearing at the top of Form 940.

What companies must file Form 940?

Each employer covered by the Federal Unemployment Tax Act must file a Form 940 (or 940-EZ). When there has been a sale of the business entity, only the wages paid by that employer should be reported. If two companies merge or consolidate in a statutory merger, the entity that results is the employer that must file the Form 940, since it is now considered the same employer as the absorbed corporation. It must report the wages paid by both corporations. The first return it files after the merger must have a statement attached with the following information: the fact of the merger; date of the merger; and the absorbed corporation's name, address, and employer identification number. 23 Successor employers. Even though a successor employer may be allowed to include wages paid by a predecessor company to Employees of both companies when determining whether the FUTA wage base has been met, generally each company must file its own Form 940 for wages it paid. There is an exception where the successor acquires a predecessor that was not an employer covered by FUTA (e.g., the sale takes place early in the year before the employer pays enough Employees to be covered by FUTA). In that situation, the predecessor does not have to file a Form 940. The successor must file Form 940, and cannot file Form 940-EZ. IRS provides the form. By the end of the calendar year, employers that have filed Form 940 in the past will receive a new form from the IRS with a reprinted address label. Employers that do not receive a Form 940 from the IRS should request the form so it can be received, completed, and returned on time. If an employer receives a Form 940 but has no FUTA tax liability, the words "Not Liable" should be written on the front of the form and the form should be signed and returned to the IRS. Form must have employer's signature. Before returning the Form 940, the form must be signed by:

Other individuals may sign the return as an agent of the employer or if they have a valid power of attorney.

When must Form 940 be filed?

Generally, an employer must file Form 940 (or Form 940-EZ) by January 31 of the year after the FUTA tax liability was incurred (e.g., Form 940 for 2004 FUTA liability must be filed by January 31, 2005). If January 31 is a Saturday, Sunday, federal holiday, or state holiday (in the state containing the IRS office where the return is to be filed), the form is due on the next business day. Employers get an automatic extension to February 10 if they have deposited their FUTA tax liability in full and on time for all four quarters (although quarterly liabilities of $100 or less for the first three quarters may be carried over to the next quarter rather than deposited without affecting the right to the automatic extension). To get the extension, an employer whose fourth quarter liability is $100 or less must deposit the amount owed by January 31 rather than send in payment with Form 940. Filers of Form 940 are allowed a special extension that is unavailable to filers of most other employment tax returns. For good cause, the IRS will grant extensions of up to 90 days, so long as an application for the extension was filed by the due date of the form. The application may be in the form of a letter detailing the reasons for the extension request. Regardless of the filing extension, however, all FUTA tax payments must be made on time.

SOME PRIVATE DELIVERY SERVICES ARE AS GOOD AS MAIL

Before 1998, Form 940 was timely filed if it was postmarked by the U.S. Postal Service on or before the due date. If a method other than the U.S. mail was used to send the form, the date of receipt by the IRS determined the form's timeliness. These restrictions were relaxed somewhat in 1997 to allow the IRS to designate private delivery services that will qualify as comparable to the U.S. mail, so that a Form 940 will be timely filed if provided to the delivery service on or before the due date.

Where must Form 940 be filed?

After Form 940 has been completed and signed, it should be mailed, sent by private delivery service, or hand delivered to the IRS service Center for the region where the employer has its principal place of business. The addresses of the IRS service Centers are listed in the Form 940 instructions. If a FUTA tax payment is made with Form 940, different addresses listed in the form must be used. Changes in filing locations caused by IRS reorganization. As part of the reorganization of the IRS mandated by the IRS Restructuring and Reform Act of 1998, all employers will file their 2003 Forms 940 in either the Cincinnati or Ogden Service Centers, which will handle all receipt and processing of business returns (including employment tax returns). The only exceptions are returns sent with payments, which will go to addresses in Dallas or Atlanta, and returns filed by employers in Puerto Rico or the U.S. Virgin Islands, which must be filed in the Philadelphia Service Center (these employers send Forms 940 with payments to Cincinnati). These changes are reflected on the address labels provided to employers with Form 940, as well as in the form's instructions.

How to amend incorrect Forms 940?

Employers that make an error on Form 940 and need to file an amended return can do so by filing a new Form 940 for the same year as the year being amended with the correct numbers. Check the box above Part I indicating an amended return is being filed. The employer should attach a statement explaining why the amended return is necessary (e.g., the 90% credit is being claimed for state contributions paid after the Form 940 due date). The amended return should be sent to the same IRSservice Center as the original Form 940. Employers filing an amended return after June 30 to claim contributions to a state unemployment fund paid after January 31 should attach a copy of the certification from the state. This will expedite the processing of the amended return. Employers that are claiming a refund of overpaid taxes must also attach Form 843, Claim for Refund and Request for Abatement, on which an explanation of the reason for the refund must be detailed.

Employers that go out of business

Employers that cease doing business must file a Form 940 for the portion of the last calendar year they were in business and check the box on the line below Question C above Part I indicating no future returns will have to be filed. The form must also have a statement attached including the following information: the location where required records will be kept; who is responsible for keeping the records; and the name and address of the purchaser of the business or the fact that there was no purchaser or that the purchaser's name is unknown.