FUTA Credit Reduction

The Federal Unemployment Tax Act (FUTA) funds unemployment benefits for workers who lose their jobs. Employers are generally required to pay a FUTA tax of 6% on the first $7,000 of wages paid to each employee annually. However, employers can receive a credit of up to 5.4% for paying state unemployment taxes on time, effectively reducing their FUTA tax rate to 0.6%.

What is FUTA Credit Reduction?

FUTA credit reduction occurs when a state has not repaid money borrowed from the federal government to cover unemployment insurance benefits. States with outstanding federal loans at the end of two consecutive years must begin repaying these loans through an automatic increase in the federal unemployment tax rate for employers in that state.

The credit reduction increases the effective FUTA tax rate for employers in affected states, resulting in a higher overall tax liability.

How Does It Work?

1. Standard FUTA Tax Rate: Employers start with a 6% tax rate.
2. Standard Credit: Employers are usually entitled to a 5.4% credit for paying state unemployment taxes, reducing their rate to 0.6%.
3. Credit Reduction: For states subject to a credit reduction, the credit decreases by 0.3% in the first year of reduction, with further increases in subsequent years.

Key Impacts on Employers

• Increased Tax Costs: Employers in credit reduction states will owe higher FUTA taxes.
• Budget Adjustments: Businesses should plan for higher unemployment tax costs when operating in affected states.
• Annual Changes: The list of credit reduction states and the applicable rates can change annually based on the states’ repayment progress.
  
  

How to Stay Informed

Employers can review the U.S. Department of Labor’s updates on credit reduction states to anticipate potential FUTA tax increases. Additionally, timely payment of state unemployment taxes ensures that employers maximize their credit under FUTA.

Adding credit reduction in Avionte

To reflect the FUTA credit reduction state and the rate on the tax reports, including the 940 Schedule A report, you will enter the credit reduction rate in Admin Tools > Employer > Tax > Tax Rate.

Click Add New, then search for FUTA ER for the applicable state.

• Enter the rate along with 1/1/XXXX and 12/31/XXXX as the start and end dates. Click Save.
• For example, for CA, there is a credit reduction of 0.06% for 2023. By selecting the CA FUTA ER option and entering the start and end dates of the year, we have entered and saved the rate.

Please note: if you are adding this rate after Jan 1, or mid-way through the year, you may need a tax recalculation to see the tax on your tax reports.