Federal Unemployment Tax Is a Payroll Tax That Funds Jobless Benefits

Federal Unemployment Tax (FUTA) is a tax that employers pay into a federal fund. That fund pays unemployment insurance benefits to workers who lose their jobs. You do not pay this tax as an employee — your employer does. The tax rate is set by federal law, and the money collected goes to the U.S. Department of Labor, which distributes it to state unemployment programs.

FUTA is separate from state unemployment tax, which most states also collect from employers. Together, federal and state unemployment taxes create the pool of money that pays your unemployment benefits if you become jobless. The federal portion funds the administrative costs of state programs and provides loans to states when their unemployment funds run low during recessions.

Key Takeaways

  • Employers pay FUTA tax at a federal rate of 6 percent on the first $7,000 of each employee's annual wages, though most employers receive a credit that reduces the effective rate to 0.6 percent.
  • FUTA money funds the administrative costs of state unemployment programs and provides emergency loans to states when their unemployment reserves are depleted.
  • You do not pay FUTA as an employee; it is entirely an employer tax, though it indirectly supports the benefits you may receive if you lose your job.
  • The federal tax rate and wage base are set by Congress and do not change based on how many claims your state receives, unlike state unemployment tax rates.

How the FUTA Tax Rate Works

The federal unemployment tax rate is 6 percent of the first $7,000 of each employee's wages per year. That means an employer pays a maximum of $420 per employee annually in federal unemployment tax. However, most employers do not pay the full 6 percent. Instead, they receive a credit of up to 5.4 percent if they pay their state unemployment tax on time and in full. This credit reduces the effective federal rate to 0.6 percent for most employers.

The $7,000 wage base is the amount of each worker's annual pay that is subject to FUTA tax. Once an employee earns $7,000 in a calendar year, no more FUTA tax is owed on their wages for that year. This wage base has remained at $7,000 since 1983 and does not adjust for inflation.

Some employers pay a higher effective rate if they are in a state with a high unemployment rate or if they have not paid their state unemployment taxes. These employers do not receive the full 5.4 percent credit and must pay more in federal tax. This is rare and usually temporary.

What Happens to the Money Collected

FUTA revenue goes into two federal trust funds managed by the Department of Labor: the Unemployment Trust Fund and the Federal Unemployment Account. The Unemployment Trust Fund holds money that states draw from to pay regular unemployment benefits to workers. The Federal Unemployment Account pays for the administrative costs of running state unemployment programs, such as processing claims and verifying work history.

When a state's unemployment fund runs low — typically during a recession when many people file claims at once — the federal government can loan money from the Federal Unemployment Account to that state. States must repay these loans, usually by paying higher federal unemployment taxes or by raising their state unemployment tax rates. If a state does not repay a federal loan within a certain time, the federal credit available to employers in that state is reduced, which increases the effective FUTA rate those employers pay.

The money collected does not go into a personal account tied to you. Instead, it funds a shared pool that all states draw from to pay benefits to any worker in that state who meets the state's requirements for joblessness.

Who Pays FUTA and Who Does Not

Most employers who have employees on a payroll must pay FUTA tax. However, some employers are exempt. Agricultural employers who pay less than $20,000 in wages in a calendar quarter or who employ fewer than 10 workers are exempt. Household employers — people who hire domestic workers like nannies or housekeepers — are exempt if they pay less than $1,000 in wages in a calendar quarter.

Some organizations are also exempt from FUTA, including certain nonprofits, government agencies, and Indian tribes. Self-employed people do not pay FUTA tax on their own income, though they may pay self-employment tax instead, which funds Social Security and Medicare.

If you are an employee, you never pay FUTA tax directly. Your employer withholds income tax and Social Security and Medicare taxes from your paycheck, but FUTA is paid entirely by the employer and does not appear on your pay stub.

FUTA Versus State Unemployment Tax

Every state except South Dakota has a state unemployment tax system in addition to the federal FUTA system. State unemployment tax rates vary widely — from less than 1 percent to more than 5 percent — and are based on factors like the employer's industry, how many former employees have filed claims, and the state's overall unemployment rate. Federal FUTA, by contrast, has a flat rate set by Congress that does not change based on state conditions.

State unemployment taxes usually apply to a higher wage base than FUTA. Most states tax wages up to $7,000 to $42,000 per year, depending on the state. When you file for unemployment benefits, you are drawing from your state's fund first. The federal fund provides backup support and administrative funding.

Both systems are designed to work together. The federal system ensures that all states have a minimum level of funding and administrative support, while state systems allow each state to set rates and benefit levels based on local economic conditions.

How FUTA Affects Your Unemployment Benefits

FUTA does not directly determine whether you receive unemployment benefits or how much you receive. Your state's unemployment program sets the rules for who is may be able to access, how long benefits last, and how much you receive each week. However, FUTA funding makes it possible for your state to process your claim and pay your benefits.

If your state's unemployment fund becomes depleted — which happens during severe recessions — the federal government can loan money to your state so that benefits continue to be paid while the state rebuilds its reserve. Without FUTA funding and the federal loan mechanism, some states would run out of money and be unable to pay benefits to jobless workers.

The amount you receive in weekly benefits depends on your state's formula, which typically uses your earnings history from the past year or two. FUTA tax does not fund individual benefit amounts; it funds the system that processes and pays those benefits.

Frequently Asked Questions

Do I pay FUTA tax as an employee?

No. FUTA is an employer tax only. Your employer pays it from their business revenue, not from your wages. You will not see FUTA deducted from your paycheck.

What is the difference between FUTA and FICA?

FUTA funds unemployment benefits and is paid only by employers. FICA (Social Security and Medicare tax) is paid by both employees and employers and funds retirement, disability, and health insurance programs. You see FICA deducted from your paycheck; you do not see FUTA.

Can FUTA tax rates change?

The federal FUTA rate of 6 percent is set by Congress and rarely changes. However, the credit that reduces the effective rate can change if states do not repay federal loans on time. Individual employers may pay a higher effective rate if they are in a state with unpaid federal debt.

Why is the FUTA wage base still $7,000?

Congress set the wage base at $7,000 in 1983 and has not raised it since, even though wages and inflation have increased significantly. This means FUTA tax covers a smaller percentage of total wages than it did 40 years ago, which has reduced federal unemployment funding over time.

What happens if my employer does not pay FUTA?

If an employer fails to pay FUTA, the Department of Labor can pursue collection through liens, wage garnishment, or legal action. However, this does not affect your right to file for unemployment benefits. Your state will still process your claim and pay benefits from the state fund.