Federal Unemployment Tax Act (FUTA): What It Means for Employers

What it means in practice

FUTA works alongside each state's unemployment insurance system. The Department of Labor says the federal tax pays the costs of administering the unemployment insurance and Job Service programs in all states, pays one-half of the cost of extended benefits during periods of high unemployment, and funds a pool from which states may borrow to pay benefits. The state tax is used only to pay benefits to eligible unemployed workers; see State Unemployment Tax Act (SUTA). For how FUTA fits with the other taxes an employer pays from its own funds, see employer payroll taxes.

The statute in brief. Section 3301 of the Internal Revenue Code imposes on every employer, for each calendar year, an excise tax equal to 6 percent of the total wages it pays with respect to employment. Section 3306(b)(1) excludes from "wages" anything an employer pays an individual during a calendar year after the first $7,000. Section 3302 allows credits for contributions paid into state unemployment funds, but section 3302(c)(1) caps total credits at 90 percent of the tax, which is how the maximum credit comes to 5.4% of wages (90% of 6.0%).

Who must pay: three independent tests. Publication 15 (2026) sets out three tests, each covering a different category of employee. Under the general test, an employer is subject to FUTA tax in 2026 if it paid wages of $1,500 or more in any calendar quarter in 2025 or 2026, or had one or more employees for some part of a day in 20 or more different weeks in either year; the Form 940 instructions say to count full-time, part-time and temporary employees, but not a partnership's partners. Under the household employees test, the trigger is cash wages of $1,000 or more to household employees in any calendar quarter in 2025 or 2026. Under the farmworkers test, it is cash wages of $20,000 or more to farmworkers in any quarter, or 10 or more farmworkers on some part of a day in 20 or more different weeks, in either year. Wages paid to H-2A visa workers count toward the farmworker tests but are not themselves subject to FUTA tax.

Employees only, not contractors. FUTA applies to wages paid for employment, so payments to a true independent contractor are outside it. The Department of Labor notes that worker misclassification means an employer does not remit the federal and state employment taxes it owes, and that state unemployment agencies use their own rules to decide what counts as employment for state purposes. The Form 940 instructions add that payments to nonemployees whom a state unemployment agency treats as employees are reported on the form.

Employers and services that are exempt. The Form 940 instructions state that section 501(c)(3) organizations generally are not subject to FUTA tax unless they pay wages on behalf of a non-501(c)(3) organization. Services for a state or its political subdivisions are exempt, as are services for a federally recognized Indian tribal government that participated in the state unemployment system for the full year and complied with state law. Publication 15 says FUTA does not apply to employers in American Samoa, Guam and the Northern Mariana Islands, but does apply in the U.S. Virgin Islands and Puerto Rico.

Family employees. Under Publication 15, payments to a child under age 21 working for a parent, to a person working for a spouse, and to a parent employed by a child are not subject to FUTA tax. These exceptions do not apply when the employer is a corporation, a partnership (unless, for a child, each partner is a parent) or an estate. The nepotism entry discusses family hiring more broadly.

Payments that are, and are not, FUTA wages. The Form 940 instructions list salaries, commissions, bonuses, vacation allowances, sick pay, noncash fringe benefits and reported tips of $20 or more in a month. Publication 15 adds that overtime, severance pay and supplemental wages are subject to FUTA tax. Payments that may be exempt include employer contributions to accident or health plans, section 125 cafeteria plan benefits, employer contributions to a qualified retirement plan, dependent care assistance excludable under section 129 (up to $5,000 per employee, $2,500 if married filing separately, in the 2025 Form 940 instructions), workers' compensation and certain meals and lodging. The Publication 15 table treats elective 401(k) deferrals as taxable for FUTA, ends FUTA on sick pay six calendar months after the last month worked, and exempts students working for the school they attend and students employed by organized camps.

How the credit works. The IRS says an employer gets the maximum 5.4% credit if it paid state unemployment tax in full, by the due date of Form 940, on all the same wages subject to FUTA tax, and the state is not a credit reduction state. An employer whose state assigned it a 0% rate is still treated as entitled to the maximum credit. When an employer's state experience rate is below 5.4%, an "additional credit" covers the difference between what it actually paid and what it would have paid at 5.4%, so a low state rate does not reduce the federal credit. Amounts that do not count as state contributions include anything deducted from employee pay, penalties, interest, special administrative taxes, voluntary contributions made to get a lower experience rate, surcharges and employment and training taxes.

When the credit shrinks. Two common situations raise the effective rate. First, if some FUTA wages are excluded from state unemployment tax (Publication 15 gives wages paid to corporate officers, certain union sick pay and certain fringe benefits as examples in some states), no state credit is available on those wages, so FUTA applies at up to 6.0%. Second, if state tax is paid late, meaning after the Form 940 due date, the Form 940 worksheet allows a credit of only 90% of the late amount (the worksheet multiplies late payments by 0.900).

Credit reduction states. The IRS explains that a state becomes a credit reduction state if it has outstanding federal unemployment loan balances on January 1 for two consecutive years and does not repay them in full by November 10 of the second year. The reduction is 0.3% for the first year, another 0.3% for the second, and 0.3% more for each later year, with possible add-on reductions from the third and fifth years. For 2025, the IRS Schedule A instructions list California at 1.2% and the U.S. Virgin Islands at 4.5%, matching DOL's historical table. DOL's potential 2026 table (updated September 11, 2026) lists the same two jurisdictions with preliminary estimates; the final 2026 list comes after November 10, 2026. The IRS says extra FUTA from a credit reduction is treated as incurred in the fourth quarter and is due by January 31 of the following year.

How it works quarter by quarter. Publication 15 says to figure FUTA quarterly: multiply the taxable wages paid in the quarter by 0.6% (adjusted if the full credit is not available) and stop once an employee's taxable wages reach $7,000 for the year. If the liability, plus any carryover, is over $500, it is deposited by electronic funds transfer by the last day of the month after the quarter; otherwise it carries forward. Deposit mechanics and penalty tiers are covered in federal tax deposit.

Form 940 at a high level. Form 940 is the annual FUTA return. Topic 759 states it is due January 31, or February 10 if all FUTA tax was deposited when due, moving to the next business day when the date falls on a weekend or legal holiday; for 2025 returns the IRS lists February 2, 2026, and February 10, 2026. The return subtracts exempt payments and amounts over $7,000 per employee from total payments, applies 0.006, then adjusts for excluded wages, late state payments and credit reductions. Schedule A is required for wages paid in more than one state or in a credit reduction state. Household employers generally report FUTA on Schedule H (Form 1040) instead.

Example 1: a typical small employer (illustration). A business in a state that is not a credit reduction state has three employees, each paid $2,500 a month in 2026, and pays its state unemployment tax on time. Each employee passes $7,000 in March, so all FUTA wages ($21,000) fall in the first quarter. The tax before credit is $1,260 (6.0%), the credit is $1,134 (5.4%), and the FUTA tax is $126, or $42 per employee. Because $126 is not over $500, no deposit is required for the quarter, and the amount can be paid with Form 940 or deposited, under the fourth-quarter rule in Publication 15.

Example 2: a credit reduction state (illustration). An employer pays one California employee $40,000 in 2025. FUTA wages are $7,000. The base FUTA tax at 0.6% is $42.00, and California's 1.2% credit reduction adds $84.00 ($7,000 x 0.012), for $126.00 in total. The California Employment Development Department makes the same point: the 2025 credit falls from 5.4% to 4.2%, so California employers pay an extra $84 per employee for 2025. The $84 is reported on Schedule A and, per the IRS, belongs with the fourth-quarter deposit.

Example 3: wages excluded from state tax (IRS example). In the Form 940 instructions, two corporate officers whose wages are excluded from state unemployment tax are paid $9,000 of first-quarter FUTA wages, and one regular employee $4,000. FUTA is $540 on the officers (6.0%) plus $24 on the employee (0.6%); the $564 total is over $500, so it must be deposited by April 30.

Where states differ. FUTA is the same in every state, but each state sets its own unemployment tax rates and wage base. As an example, California's Employment Development Department lists a 2026 unemployment insurance taxable wage limit of $7,000 per employee, the same as the federal base, plus a separate 0.1% Employment Training Tax, a type of charge the Form 940 instructions exclude from the credit. The EDD also describes FUTA recertification: each year the EDD and the IRS compare Form 940 amounts with wages on the state's quarterly DE 9 return, and a mismatch can bring a notice from either agency.

Recordkeeping. Publication 15 says to keep employment tax records for at least four years. The Form 940 instructions say to keep the line 10 credit worksheet with your records rather than attach it.

Question: Can FUTA be deducted from an employee's paycheck? No. The Form 940 instructions state that only employers pay FUTA tax and tell employers not to collect or deduct it from employees' wages. That is a key difference from FICA, where the employee pays half.

Question: Does the $7,000 base restart if an employee changes jobs? The base applies per employer: the statute excludes pay above the first $7,000 paid "by an employer" in a calendar year, so a new employer generally starts again at zero. The exception is a successor employer that acquires substantially all the property of a business and keeps its employees, which may count the predecessor's wages.

Question: Where are credit reduction states published? DOL announces them after November 10 each year on its FUTA Credit Reductions page, and the IRS lists the states and rates in that year's Schedule A (Form 940) instructions.

This entry describes the federal baseline for 2026 and does not cover every special class of employment in the Publication 15 table. Confirm the details for your situation with the IRS or a qualified professional.

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