Employers pay federal unemployment tax, not employees
Federal Unemployment Tax Act (FUTA) tax is paid by employers, not taken from your paycheck. The employer sends this money to the federal government, which funds the unemployment insurance system that pays benefits to workers who lose their jobs. You will not see FUTA deducted on your pay stub because it is a business expense the employer covers separately.
The federal rate is 6 percent of the first $7,000 you earn each year, but employers can reduce this to 0.6 percent if they pay state unemployment tax on time. This means most employers actually pay 0.6 percent in federal tax once they are current on their state payments. The state unemployment tax (SUTA) is what varies by state and sometimes by industry.
Self-employed people do not pay FUTA tax at all. Only employers with employees owe it. If you work as a contractor or run a business without employees, you do not file FUTA returns or make FUTA payments.
Key Takeaways
- Employers pay federal unemployment tax directly to the U.S. Department of Labor, not from employee paychecks.
- The federal rate is 6 percent of the first $7,000 of each employee's annual wages, but drops to 0.6 percent for employers current on state unemployment tax.
- Self-employed workers and business owners without employees do not pay federal unemployment tax.
- State unemployment tax (SUTA) is separate from federal tax and varies by state, with rates typically between 0.5 and 5.4 percent depending on the state and the employer's history of layoffs.
- Employers report FUTA tax on Form 940, filed annually with the IRS by January 31.
How the federal rate becomes 0.6 percent for most employers
The federal unemployment tax starts at 6 percent, but Congress designed it to drop to 0.6 percent if you pay your state unemployment tax in full and on time. This is called the credit reduction. Almost every employer qualifies for this credit because state unemployment tax is mandatory in all 50 states, and most employers pay it automatically through payroll.
The credit only fails if an employer falls behind on state unemployment tax payments. If you owe back state unemployment tax, the IRS will not let you reduce your federal rate. Once you catch up on state payments, the credit applies again in the next tax year.
This system means the federal government collects only 0.6 percent from most employers, while states collect their own unemployment tax on top of that. The state rate is what changes based on how many former employees have filed for benefits — employers with high layoff histories pay more to their state.
What wages count toward the $7,000 annual cap
Federal unemployment tax applies only to the first $7,000 of wages you pay each employee per calendar year. Once an employee earns $7,000, you stop calculating FUTA tax on their wages for the rest of that year. This cap resets on January 1.
Wages include salary, hourly pay, bonuses, and commissions. They also include certain fringe benefits like health insurance premiums the employer pays on the employee's behalf. Reimbursements for business expenses and gifts under $25 do not count as wages for FUTA purposes.
The $7,000 cap is per employee, not per business. If you have 10 employees, you calculate FUTA on $7,000 for each of them separately. Once each individual employee crosses $7,000 in a calendar year, you stop the FUTA calculation for that person until the next January 1.
Who must file and pay federal unemployment tax
You must pay federal unemployment tax if you had employees during any part of a calendar quarter and paid them $1,500 or more in wages during that quarter. The threshold is $1,500 per quarter, not per year — if you paid $500 in one quarter and $1,200 in another, you owe FUTA for both quarters.
Household employers (people who hire nannies, housekeepers, or yard workers) must pay FUTA if they pay a household employee $2,400 or more in a calendar year. Agricultural employers have a different threshold of $20,000 in a calendar year or 10 or more employees for any part of a day in 20 different weeks.
Employers file FUTA taxes on Form 940 with the IRS. The form is due by January 31 of the following year, though you must make quarterly deposits throughout the year if you owe more than $500 in a quarter. Most employers use payroll software or a payroll service to handle these deposits automatically.
State unemployment tax is separate and usually higher
Every state runs its own unemployment insurance program and collects state unemployment tax (SUTA) from employers. State rates vary widely — from as low as 0.5 percent in some states to as high as 5.4 percent or more in others. The rate depends on the state's unemployment fund balance and the employer's individual layoff history.
New employers usually pay the state's standard rate for their industry. Established employers pay a experience rating — a rate based on how many former employees have drawn benefits. If your company has laid off many workers who then filed for unemployment, your state rate goes up. If you have few layoffs, your rate may drop below the standard.
State unemployment tax is calculated on a higher wage base than federal tax in most states. While federal tax stops at $7,000 per employee per year, many states tax wages up to $9,000, $10,000, $15,000, or even higher. This means state unemployment tax is usually the larger expense for employers.
How unemployment benefits connect to these taxes
When you lose your job through no fault of your own, you may be able to file for unemployment benefits through your state. The money for these benefits comes from the unemployment taxes employers paid into the state fund. Federal unemployment tax funds the administrative costs of running the system — paying staff at state unemployment offices, maintaining the filing system, and processing claims.
Your benefit amount and how long you can receive benefits depend on your state's rules and how much you earned while employed. The federal government sets a baseline, but each state decides its maximum weekly benefit, how many weeks you can collect, and what disqualifies you. During recessions or national emergencies, the federal government sometimes extends benefits beyond the state's normal duration.
You do not need to have paid unemployment tax yourself to receive benefits — only your employer needs to have paid it. Self-employed workers and independent contractors do not pay unemployment tax and generally cannot file for unemployment benefits, though some states have created special programs for self-employed people during economic crises.
Frequently Asked Questions
Can an employee ask their employer to pay less FUTA tax?
No. FUTA tax is a legal obligation on the employer, not a negotiable expense. Employees cannot reduce it, and employers cannot shift it to workers. The amount owed is determined by federal law based on wages paid and the employer's state unemployment tax status.
What happens if an employer does not pay federal unemployment tax?
The IRS can assess penalties, interest, and back taxes. Employers who fail to pay FUTA can face civil penalties of 5 to 25 percent of the unpaid tax, plus interest calculated daily. The IRS can also place a lien on the business or pursue collection through wage garnishment or bank levies.
Do nonprofit organizations pay federal unemployment tax?
Most nonprofits do not pay FUTA tax because they are exempt under federal law. However, they must still pay state unemployment tax in most states. Some nonprofits choose to reimburse the state directly for benefits paid to former employees instead of paying ongoing state unemployment tax — this is called the reimbursement method.
Is federal unemployment tax the same as Social Security and Medicare tax?
No. FUTA is separate from Social Security and Medicare taxes (FICA). FICA taxes are split between employer and employee — the employee sees these deducted on their paycheck. FUTA is paid entirely by the employer and does not appear on employee paychecks. All three are separate federal payroll taxes with different purposes and rates.
What if an employee works for multiple employers in one year?
Each employer calculates and pays FUTA based on the wages they paid that employee. The $7,000 annual cap applies to each employer separately, not across all employers. If you work for two employers and earn $7,000 from each, both employers owe FUTA tax on their $7,000 of wages to you.