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Employers pay various taxes to the government on behalf of their employees. Some of these are collected from the employees, while others are the employers’ responsibility solely. One of the taxes falling under the latter category comes from the Federal Unemployment Tax Act.
What is the Federal Unemployment Tax Act (FUTA)?
The Federal Unemployment Tax Act (FUTA) is a U.S. federal law enacted in 1939 under the Social Security Act. FUTA established the federal unemployment insurance program, providing temporary financial assistance to eligible workers without jobs. Under FUTA, employers must pay taxes to fund the unemployment insurance program. The tax is based on employees’ wages and differs from other payroll taxes such as Social Security and Medicare.
The funds collected through FUTA taxes help provide states with financial resources to administer their own unemployment insurance programs. Each state sets its own eligibility criteria and benefit amounts within specific federal guidelines. States have the flexibility to determine the duration and level of benefits provided to unemployed workers.
How does the Federal Unemployment Tax Act work?
The federal unemployment tax act requires employers to pay taxes based on their employees’ wages to fund the program. The FUTA tax rate is 6% of the first $7,000 of each employee’s wages, but employers can receive a credit of up to 5.4% if they pay their state unemployment taxes on time, effectively reducing the federal tax rate to 0.6%. Employers report and pay FUTA taxes quarterly to the Internal Revenue Service (IRS).
The funds collected through FUTA taxes are then distributed to individual states to support their unemployment insurance programs. Each state administers its program within the guidelines set by FUTA. State agencies process unemployment claims, determine eligibility, and calculate benefit amounts. The benefits get provided to eligible individuals who have lost their jobs. The specific duration and amount of these benefits vary from state to state.
Workers who become unemployed can apply for unemployment benefits through their state’s unemployment agency. The state agency reviews the claims, verifies eligibility, and provides regular benefit payments to approved individuals for a specified period. FUTA empowers states to assist in offering temporary financial support to eligible workers during their unemployment.
How to calculate the Unemployment Tax under the Federal Unemployment Tax Act?
Employers and companies must follow various steps to calculate unemployment taxes under the federal unemployment tax act. These are as below.
1. Determine the FUTA taxable wages
Employers must identify the total taxable wages paid to employees during the relevant period. FUTA taxes apply to the first $7,000 of every employee’s wages in a calendar year.
2. Calculate the FUTA taxable wages for each employee
For employees whose wages exceed $7,000 in a calendar year, employers must only consider the initial $7,000 for FUTA purposes. If the wage is $7,000 or less, the total wages get treated as FUTA taxable.
3. Apply the FUTA tax rate
As of the cutoff in September 2021, the FUTA tax rate stands at 6% of the FUTA taxable wages. Employers must multiply the aggregate FUTA taxable wages for all employees by 6% to derive the FUTA tax liability.
4. Consider state unemployment tax credits
Employers who adhere to state regulations and promptly pay their state unemployment taxes may qualify for a credit against their FUTA tax liability. Typically, this credit amounts to 5.4% of the FUTA taxable wages. They must subtract the applicable credit amount from the FUTA tax liability calculated in step 3 to determine the net FUTA tax owed.
The Federal Unemployment Tax Act requires companies and employers to pay unemployment tax on their employees’ behalf. This act falls under the Social Security Act. It requires employers to pay 6% of up to $7,000 of the employee’s wages. However, tax credits may apply in some areas, bringing it down to 0.6%.
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