As a small business owner, it’s important to understand the impact of the Federal Unemployment Tax Act (FUTA) on your business. FUTA is a federal law that requires employers, including small businesses like yours, to pay a tax on the wages they pay to their employees. This tax is used to fund state unemployment insurance programs, which provide financial assistance to workers who have lost their jobs through no fault of their own.
The FUTA tax rate is 6% on the first $7,000 of wages paid to each employee per year, but employers automatically receive a credit of to 5.4% against this tax, reducing the effective rate to 0.6% ($42 max per employee per year).
However, when a state has not maintained a sufficient balance in its unemployment trust fund and must borrow funds from the federal government, employers are subject to a credit reduction. This means that the 5.4% credit against the FUTA tax is reduced, therefore increasing the effective overall rate.
For example, let’s say that a small business in a state with a credit reduction of 0.3% has 50 employees and paid them $7,000 in wages each. Normally, the employer would pay $2,100 in FUTA taxes ($7,000 wages x 0.6% FUTA rate X 50 employees). However, with the credit reduction, the employer would pay $3,150 in FUTA taxes ($7,000 x 0.9% x 50 employees). The credit reduction would have increased the employer’s FUTA tax liability by $1,050.
The FUTA credit reduction is not finalized until December, so employer’s have very little notice about the additional tax bill they have to pay, since the tax is due by January 31.
The credit reduction can have a significant impact on small business owners like yourself. Depending on the number of workers you employ, it can add hundreds or even thousands of dollars to your annual tax bill, which can be a significant burden on your business, especially if you’re already struggling to make ends meet.
There are a number of factors that can contribute to a state needing to borrow funds from the federal government to maintain its unemployment trust fund. One of the most common is a high unemployment rate. When more people are out of work, more claims are filed for unemployment benefits, which can drain a state’s trust fund. Another factor is a lack of sufficient funding through state unemployment taxes. States that do not contribute enough money to their trust funds may find themselves unable to keep up with the demand for benefits. This can lead to a shortfall and a credit reduction.
You can check the U.S. Department of Labor (DOL) website for a list of states with credit reductions in the current year.
In conclusion, as a small business owner, it’s important to understand the impact of the FUTA credit reduction on your business and take steps to mitigate its impact, by being aware of it and checking the DOL website for updates. Your payroll provider can also assist and help you understand how much additional FUTA tax you may have to pay if you are in an impacted state. By staying informed and taking action, you can help to mitigate its impact.