Federal Unemployment Tax Act (FUTA) Definition

The Federal Unemployment Tax Act (FUTA), defined as a tax that an employer alone must pay. Although the employer pays this tax, it is based solely on the amount of work and pay per employee for that particular company. As said before, the Federal Unemployment Tax act is a tax paid by employers as a safeguard against the unemployed losing their funds. As a benefit to unemployed workers during the time they don’t have employment, FUTA is a federally implemented and controlled construct.

Federal Unemployment Tax Act FUTA Meaning

FUTA is different from FICA taxes and Social Security taxes because the latter two are paid half by employer and the other half by the employee. However, FUTA is based on an employees wages. But the employer only pays this. Luckily for employers the federal unemployment rate is quite low, hovering around 0.8%. Included with the federal unemployment tax rate is the fact that an employer only has to pay for the first \$7,000 per year.

Federal Unemployment Tax Act (FUTA) Example

When calculating the payment to be realized for the unemployment tax, it is important to understand what taxable wages are. Taxable wages are potential taxable income. Additionally, other wages are non-taxable or in other words, untaxable wages. Therefore, when the Federal Unemployment Tax states that the first \$7,000 wages are taxable,  any wages over \$7,000 are not taxable.

For example, if an employee in a company was earning \$10,000, then they would only be taxed for \$7,000 of their salary at the rate per working employee. At the same time, one must also know the number of taxable employees, as well as the rate that the tax will be implemented. For example, Bob is the CFO for Mundler Diffin. Mundler Diffin is a company that specializes in the sale of construction paper. The company has 40 employees who all make on average \$40,000 a year plus commission. Bob then calculates Mundler Diffin’s unemployment tax liability using the following equation:

40 employees * \$7,000 * 0.8% = \$2,240

[box]Note: If each employee made less than \$7,000, then multiply the rate by the total they earn up to \$7,000. The employees needs to pay this.[/box]

FUTA Credit

The prime benefactors of the Federal Unemployment tax are obviously the employees. They receive a monetary benefit that creates a cushion against prolonged unemployment. In order for the employees to benefit from the FUTA, they have to fall under certain qualifications. Likewise, companies can file for a FUTA credit that gives them the ability to reduce the rate that applies to the unemployment tax. For a company to qualify for a FUTA credit, the company must first pay all of the unemployment tax for that year on the due date. Furthermore, companies that are exempt from the Federal Unemployment tax are not a candidate for the FUTA credit. In addition, employees exempt from the benefits from the unemployment tax exclude their income from the unemployment tax payment. If companies realizes the FUTA credit, then the going rate for the unemployment payment drops from 6.2% to .8%.

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