Federal unemployment tax is a payroll tax that employers pay to fund unemployment insurance programs

Federal Unemployment Tax Act (FUTA) tax is money that employers withhold from a fund and send to the federal government. It is not taken from your paycheck. The tax finances the unemployment insurance system that pays benefits to workers who lose their jobs. Every employer in the United States pays this tax on wages they pay to employees, with very few exceptions.

The federal rate is 6% of the first $7,000 each employee earns per year. However, employers who pay state unemployment tax on time receive a credit that reduces what they owe federally. In practice, most employers pay 0.6% federal tax after taking this credit. The employer decides whether to pass this cost along to workers or absorb it as a business expense — it does not appear on your pay stub.

FUTA tax is separate from state unemployment insurance tax, which varies by state and also comes from employer payroll. Together, these two taxes create the pool of money that pays unemployment benefits when you file a claim.

Key Takeaways

  • Federal unemployment tax is paid by employers, not deducted from your wages, and funds the national unemployment insurance system.
  • The federal rate is 6% on the first $7,000 of each employee's annual wages, but most employers pay only 0.6% after receiving a state tax credit.
  • Only certain employers are exempt, including the federal government, some nonprofits, and employers with fewer than a certain number of employees in some cases.
  • The money collected goes into the federal unemployment trust fund, which states draw from when their own unemployment funds run low.

Who has to pay federal unemployment tax

Most employers pay FUTA tax if they meet one of two tests. The first test is whether they paid $1,500 or more in wages in any quarter of the current or prior year. The second test is whether they employed at least one person for at least one day in any 20 different weeks during the current or prior year. If either is true, the employer owes federal unemployment tax.

Some employers do not pay FUTA tax at all. The federal government, state governments, and certain nonprofits are exempt. Railroad employees are covered under a separate federal system. Agricultural workers and domestic workers have different rules depending on how much the employer paid them. Employers should check with the IRS or a tax professional to confirm their status, because the rules change based on the type of work and the amount paid.

How much federal unemployment tax employers owe

The standard federal rate is 6.0% of the first $7,000 of wages paid to each employee in a calendar year. That means the maximum FUTA tax per employee is $420 per year. Once an employee has earned $7,000 in a year, no more FUTA tax is owed on their wages for the rest of that year.

However, employers who pay their state unemployment tax on time and in full receive a credit against their federal tax. This credit is usually 5.4%, which brings the effective federal rate down to 0.6%. Some states have higher or lower credit rates depending on their unemployment fund balance and history of claims. A few states have rates above 5.4%, which means employers in those states may owe more than 0.6% federal tax.

Employers calculate FUTA tax quarterly and report it on Form 940 when they file their annual tax return with the IRS. They do not send FUTA tax to the state — it goes directly to the federal government.

What the federal government does with FUTA tax money

FUTA tax revenue goes into the Federal Unemployment Trust Fund, which is held at the U.S. Treasury. This fund serves two purposes. First, it pays for the administrative costs of running the unemployment insurance system in each state — things like processing claims, investigating fraud, and maintaining the systems that track benefits. Second, it provides loans to states whose unemployment funds run dry during recessions or periods of high joblessness.

When a state's unemployment trust fund balance falls too low to pay all the benefits owed, that state can borrow from the federal fund. The state is then responsible for repaying the loan, usually through higher state unemployment taxes on employers or reduced benefits to workers. During the 2008 financial crisis and the 2020 pandemic, many states borrowed heavily from the federal fund because claims far exceeded the money they had collected.

The federal fund does not directly pay unemployment benefits to individual workers. That is the job of state unemployment insurance programs, which collect their own state unemployment tax and use it to pay benefits. The federal fund is a backstop when state funds are insufficient.

How FUTA tax connects to your unemployment benefits

When you file for unemployment benefits, you file with your state, not the federal government. Your state uses money from its own state unemployment tax to pay your benefits. However, the federal system supports this process in several ways. Federal money pays for the staff and systems that process your claim. If your state's fund runs low, federal loans keep the system running so your benefits are not delayed.

The amount of benefits you receive depends on your state's rules and your prior wages, not on federal tax rates. Each state sets its own maximum benefit amount, its own duration of benefits, and its own rules about what disqualifies you. FUTA tax is the infrastructure that makes the whole system work, but it does not determine how much you receive or for how long.

States with higher federal unemployment tax rates

Most employers pay 0.6% federal unemployment tax because they receive the full 5.4% credit for paying state tax on time. However, some states have rates higher than 5.4%, which means employers in those states pay more than 0.6% federal tax. This happens when a state has borrowed from the federal fund and has not yet repaid the loan, or when a state's unemployment fund balance is very low.

When a state owes money to the federal fund, the IRS reduces the credit available to employers in that state. For example, if a state owes a large loan, employers might receive only a 5.0% credit instead of 5.4%, which means they owe 1.0% federal tax instead of 0.6%. This continues until the state repays its debt. Employers in states with loan balances should check their FUTA tax rate each year, because it can change.

Frequently Asked Questions

Does federal unemployment tax come out of my paycheck?

No. FUTA tax is paid entirely by employers. It does not appear on your pay stub and is not deducted from your wages. The employer decides whether to absorb the cost or factor it into compensation decisions.

What is the difference between federal and state unemployment tax?

Federal unemployment tax (FUTA) funds the national system and pays administrative costs. State unemployment tax funds the actual benefits you receive when you file a claim. Both are paid by employers, and both are required in most states.

Can I get a refund of federal unemployment tax?

No. FUTA tax is not refundable. It is a permanent contribution to the unemployment insurance fund. You do not receive it back as a refund, but it funds the system that pays benefits if you become unemployed.

What happens if an employer does not pay federal unemployment tax?

The IRS can assess penalties, interest, and back taxes. Employers who fail to pay can face civil and criminal penalties. If you work for an employer who does not pay, you may still be covered under state unemployment insurance if the employer meets the threshold for state tax.

Does federal unemployment tax apply to self-employed people?

No. Self-employed people do not pay FUTA tax. They pay self-employment tax, which funds Social Security and Medicare. Self-employed people may be able to pay into state unemployment insurance in some states, but the rules vary.