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Does dealing with taxes ever feel like living in a world of acronyms? We think so, too, but don’t worry, we’ll break this one down for you.
FUTA stands for Federal Unemployment Tax Act, and if you’re an employer in the United States, you’ll want to keep this one on your radar. It’s an employer-paid federal tax that goes toward payments of unemployment compensation for workers who’ve lost jobs. To start, the rate is six percent (6%), but, in most cases, employers can receive a credit when filing Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. The credit is 5.4 percent (5.4%), leaving a net FUTA tax rate of 0.6 percent (0.6%).
Pretty straightforward, right?
👉 Know the difference between US income tax and payroll tax to keep your books in order.
What are FUTA credit reduction states?
Instances where the net 0.6 percent (0.6%) rate wouldn’t apply to a state is if the state has taken out a Federal Unemployment Trust Fund loan and was unable to pay it back within the given timeframe. These are federal government loans that a state can use if it doesn’t have the funds to pay Unemployment Insurance (UI) benefits for its residents.
When a state has this kind of loan, the amount of the credit on the FUTA tax shifts, reducing by a rate determined by the Department of Labor (DOL) until the loan is repaid. The credit reduction rate starts at 0.3 percent (0.3%), and an additional 0.3 percent (0.3%) is added each year there’s still money owed.
Not only that, if there’s still a balance on the loan in year three and five, the government may reduce the credit even more.
All in all, this is why they’re referred to as credit reduction states.
How does a FUTA credit reduction state affect employers? (And Year-End?)
All right, that was a lot of state government-level information, but how does this impact you as an employer?
Remember, this is an employer-paid tax, and it’s up to you to know if your state is a FUTA credit reduction state. Keeping an eye on whether your state falls under this category can save you from stress and headaches when filing your Form 940 with the IRS.
FUTA credit reduction states for the 2022 tax year.
The DOL announces the new rates each year, usually in November.
The states affected by FUTA reduction in 2022 are: California, Connecticut, Illinois, New York and US Virgin Islands (USVI). Employers in these states will have to be mindful of the credit reduction rates that apply when filling out Form 940. The rate for 2022 is 0.3 percent with the exception of the US Virgin Islands (USVI), which is set at 3.6 percent as per the DOL.
Knowing these kinds of tax situations and rates are just another way to keep year-end running smoothly for your small business.
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