As small employers know, the FUTA tax is collected to fund the state agencies which provide unemployment compensation to workers who lose their jobs. Generally, employers pay a FUTA tax rate of 6 percent on the first $7,000 of covered wages paid to each employee during the year. Employers also pay a state unemployment insurance fund by January 31 of the following year, and are allowed a tax credit of up to 5.4 percent of the first $7,000 of covered wages. Thus the net FUTA tax rate is around 0.6 percent, or $42 per employee, per year.
The problem arises when the total amount of taxes paid into the system are not enough to cover the unemployment benefits being paid out. In order to fill the gap, the Social Security Act allows states to borrow funds from the federal government. What happens when the state is unable to repay the loan to the federal government? Well, each calendar year that the loan is not repaid starting with January 1 of the second consecutive year, the credit is reduced by 0.3 percent.
California is one of the 15 states with an outstanding federal UI loan and thus has a predicted potential credit reduction of 1.2 percent. However, the FUTA tax rate could turn out to be even higher than predicted. If the advance is not repaid by November 10, employers are subject to more credit reductions. The credit reductions are determined based upon the particular state’s unemployment insurance contribution and benefit payment experience. Although the dollar amounts are not going to be very large, companies should be aware of the variations in FUTA tax rates in their particular state. The actual credit reductions will not be known until November. Therefore, an additional tax may have to be paid with the Forms 940, which must be filed in January, 2015.