Form 940 and FUTA Tax: The Annual Unemployment Return
The 6 percent federal unemployment tax, the 5.4 percent state credit, the credit reduction states, and the annual Form 940
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
FUTA (the Federal Unemployment Tax Act tax) is an employer-only tax of 6 percent on the first US$7,000 of each employee's annual wages, reduced by a credit of up to 5.4 percent for state unemployment tax paid — a net 0.6 percent, or US$42 per employee. It is reported on Form 940, due January 31, with quarterly deposits above US$500.
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Who pays FUTA?
Employers who paid US$1,500 or more in wages in any calendar quarter, or had at least one employee for some part of a day in twenty or more different weeks during the year (different thresholds apply to household and agricultural employers). Nothing is withheld from employees — FUTA is entirely the employer's cost. Partners and sole proprietors are not employees at all; an S corporation owner-employee's wages, and wages a corporation pays to an owner's child or spouse, are subject to FUTA like anyone else's. Wages paid to a child under 21 by a sole proprietor parent (or a parents-only partnership) are exempt.
How is the tax computed?
| Step | Computation |
|---|---|
| FUTA wage base | First US$7,000 of wages paid to each employee in the calendar year (not indexed; unchanged since 1983) |
| Gross FUTA | 6.0 percent × FUTA wages |
| State credit | Up to 5.4 percent of FUTA wages, for state unemployment tax paid on time to a certified state program — even if the state rate is lower than 5.4 percent, the full credit applies in a non-credit-reduction state |
| Net FUTA | 0.6 percent × FUTA wages = US$42 per employee earning US$7,000 or more |
| Credit reduction | In states with an outstanding federal unemployment loan balance on January 1 of two or more consecutive years (not repaid by November 10), the credit is reduced — 0.3 percent at first, growing each further year, with add-ons possible in later years — raising the employer's net rate; Schedule A (Form 940) lists the states and rates each year (California 1.2 percent and the U.S. Virgin Islands 4.5 percent for 2025) |
State unemployment tax paid after the Form 940 due date earns only 90 percent of the normal credit on the late-paid amount (the additional credit for a low state rate is not reduced). Employers in more than one state complete Schedule A for the multi-state allocation and any credit reductions.
When are deposits due?
FUTA is deposited quarterly when the accumulated liability exceeds US$500: by April 30, July 31, October 31, and January 31 for the preceding quarter. Liability of US$500 or less carries to the next quarter; if the year-end total is still US$500 or less, it may be paid with Form 940. An employer with twelve employees who all cross US$7,000 by March has US$504 of liability in Q1 — deposited by April 30 — and nothing more for the year. Deposits go through EFTPS like all federal payroll taxes.
When is Form 940 due?
January 31 following the year, with an extension to February 10 if all FUTA deposits were made on time. It is an annual return: one filing covers all four quarters, showing total wages, exempt payments, wages over US$7,000, FUTA wages, the tax, the state credit and any reduction, deposits, and the balance. Part 5 breaks the liability down by quarter if it exceeded US$500 in total.
How does FUTA relate to state unemployment tax?
They are two systems. State unemployment insurance (SUI) is the larger cost — a percentage of each employee's wages up to the state's own wage base, at a rate set by the employer's experience with layoffs (the SUI guide) — and it funds the benefits laid-off workers actually receive. FUTA funds the federal share of administration and the loans to states whose funds run dry. Paying SUI on time is what earns the 5.4 percent FUTA credit; an employer that skips SUI pays the full 6 percent FUTA and still owes the state.
Worked example
A cleaning company has fourteen employees; eleven earned more than US$7,000 during the year, three seasonal workers earned US$4,000, US$5,200, and US$6,100. FUTA wages: 11 × US$7,000 + US$4,000 + US$5,200 + US$6,100 = US$92,300. Gross FUTA at 6 percent: US$5,538. The company paid its state unemployment tax on time in a state with no credit reduction: credit US$4,984 (5.4 percent). Net FUTA: US$554. Liability crossed US$500 in the second quarter (as employees reached US$7,000), so a deposit was due July 31; the remaining small amount is paid with Form 940 on January 31. Had the company been in a credit reduction state at 0.3 percent, the net rate would be 0.9 percent — US$831 instead of US$554.
Frequently asked questions
What is FUTA tax?
The federal unemployment tax — 6 percent of the first US$7,000 of each employee's wages, paid by the employer only, reduced to 0.6 percent by the credit for state unemployment tax paid on time.
What is the FUTA wage base?
US$7,000 per employee per calendar year. It is not indexed and has not changed since 1983.
What is a credit reduction state?
A state that has had an outstanding federal unemployment loan balance on January 1 of two or more consecutive years without repaying it by November 10. Employers there lose part of the 5.4 percent credit — 0.3 percent in the first year, growing each year the loan stays unpaid — and Schedule A (Form 940) lists the current states and rates.
When is Form 940 due?
January 31 for the prior year, or February 10 if all FUTA deposits were timely. Deposits are due quarterly once accumulated liability exceeds US$500.
Official sources
The IRS states: “Use Form 940 to report your annual Federal Unemployment Tax Act (FUTA) tax. Together with state unemployment tax systems, the FUTA tax provides funds for paying unemployment compensation to workers who have lost their jobs.” — Internal Revenue Service, About Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, https://www.irs.gov/forms-pubs/about-form-940
The IRS states: “The IRS has developed specific forms to correct errors on a previously filed employment tax return. However, there is no specific form to correct a Form 940. You use a Form 940 for correcting a previously filed return by checking the amended return box in the top right corner of the Form 940.” — Internal Revenue Service, Employment taxes, https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles Form 940 preparation with multi-state Schedule A, FUTA deposit tracking, state unemployment coordination for the credit, and payroll setup for new employers. See pricing or book a call.
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