All You Need To Know About the FUTA Tax
On the off chance that you possess a business, you have most likely heard about a tax known as FUTA. It is great to think about this regularly misjudged tax since it affects tax returns of a business. In this article, we intend to decipher the answers to the following common questions. What precisely is FUTA tax, who benefits from FUTA, who is required to pay FUTA tax, and how much is paid as FUTA tax.
What exactly is FUTA Tax?
The Federal Unemployment Tax Act (FUTA) is federal legislation that empowers the government to impose a tax on employers. The main aim is collecting revenue that goes to state unemployment programs. Employers are required to pay FUTA tax based on a percentage of total wages paid to employees.
After the collection of funds through the FUTA tax, the government pays unemployment compensation to employees who have lost their jobs. It is worth to note that even though the FUTA tax is based on the wages paid to employees, it is only imposed on employers. This clearly indicates that no portion of the tax is deducted from employee wages. Every employer is required to deposit the FUTA tax on a quarterly basis. Additionally, the employer should file IRS Form 940 at the end of the year.
Who Benefits From FUTA?
The focus of the FUTA tax is to provide financial relief to employees who have lost their jobs. Nonetheless, unemployment compensation is not for all employees. Notably, the compensation is only for employees who have lost jobs involuntarily through retrenchment or closure of a business. It is imperative to note that employees fired because of nonperformance or gross misconduct are not eligible for benefits provided by FUTA.
After a former employee claims unemployment insurance through the state unemployment agency, the employer receives a notice of unemployment insurance claim. That aims at finding out whether the former employee is eligible for unemployment compensation. Notably, the form requests basic information about the employee, including the reason for their loss of work. In case the employer confirms that a former employee is eligible, he or she is eligible to start receiving checks from the state unemployment agency. An employer has the option of challenging the claim if he or she believes that an ex-employee is not eligible. In case of a contest, the employer should avail documentation as evidence for the reason behind the termination of the employee’s employment.
Who Is Required To Pay FUTA Tax?
Any business in the US that has employees is required to apply for a Federal Employer ID Number (EIN). This is acts as registration for business and allows an employer to make payments towards the federal unemployment insurance. An employer is required to pay FUTA if:
The business pays wages amounting to or more than $1,500 in any calendar quarter of the year.
The business has at least one employee for some part of a day or more in at least 20 different weeks in a year. That includes full-time, part-time, and temporary employees.
A household employee is paid wages amounting to or exceeding $1,000 in any calendar quarter of the year. Typically, a household employee is an employee who performs any type of household work in a local college club, a sorority chapter, a local fraternity, or a private home.
Farm workers are paid cash wages amounting to or exceeding $20,000 in any calendar quarter during the year.
It is worth noting that an employer is not required to pay FUTA on independent contractors since they are not considered as employees. Actually, this is the sole reason why small businesses in the US prefer hiring independent contractors instead of full-time employees. Besides, businesses in the US that hire contractors are not required to pay payroll taxes like FUTA.
How much is FUTA Tax?
Similar to what was mentioned earlier, the FUTA tax is mainly based on employee wages. Particularly, the FUTA tax rate for 2018 was 6%. The FUTA tax is only applicable to the first $7,000 paid to every employee within a calendar year. That implies that an employer should stop paying the FUTA tax once when more than $7,000 is paid to an employee. The IRS refers to the $7,000 threshold as the wage base. In reference to the 6% tax rate, the maximum FUTA tax an employer should pay per employee in a given year is $420.
Employers who pay State Unemployment Tax Act SUTA can take a tax credit. The tax credit is deducted from the amount of FUTA tax on is required to pay. Apparently, the maximum tax credit allowed is 5.4% of the taxable income. That means that the effective FUTA tax rate for employers who qualify for the highest amount of tax credit is reduced to 0.6% (6% minus 5.4%). This leads to $42 as the minimum amount of FUTA tax that an employer can pay over a year.
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