On July 1, 2011, the federal unemployment tax rate dropped from 6.2 percent to 6 percent (not retroactive to the beginning of the year). The difference is minor, but a small tax decrease is better than none at all.
Depending on the circumstances, an employer could save $0 to $14 per year per employee. Federal unemployment tax, or FUTA is paid on the first $7,000 of wages per employee, per year, so for employees who have surpassed the $7,000 mark before July 2011, no savings will be realized.
Unfortunately for employers in certain states that have been hit by unusually high unemployment claims, the net FUTA rate will still increase.
To better understand the changes, here is some background information on how the FUTA system works.
Employers pay both state unemployment tax and federal unemployment tax. The IRS grants a credit for 5.4 percent for the payment of state unemployment tax, which nets against the FUTA rate.
Using the old FUTA rate of 6.2 percent, for wages paid from January to June 2011:
6.2 percent minus the credit of 5.4 percent = .8 percent. .8 percent times $7,000 equals $56 per employee per year. So for an employee who began work, for example, in January of 2011 and earned $7,000 or more before July, the total FUTA owed by the employer for the year would be $56. Using the new FUTA rate of 6 percent, for wages paid from July through December 2011:
6.0 percent minus the credit of 5.4 percent = .6 percent. .6 percent times $7,000 equals $42 per employee per year. So for an employee who began work on or after July 1, 2011 and earned $7,000 or more during the year, the total FUTA owed by the employer would be only $42, a savings of $14 compared to the old rate.
Now for the Bad News
All employers get the FUTA reduction of .2 percent, described above. Despite the reduction, in some states, employers will still pay more FUTA for 2011 and possibly 2012 and beyond. The reason is due to unprecedented unemployment claims in many areas of the country. As a result, 20 states and the Virgin Islands depleted their unemployment insurance funds and had to draw on a designated federal loan account. If these loans are not repaid within two years, the borrowing states lose part of the 5.4 percent FUTA tax credit granted by the IRS, until the loan is repaid. Each year until the loan is repaid, the tax credit is reduced by .3 percent. The net effect is that employers in the affected states pay more FUTA.
For employees who earned at least $7,000 before July, the FUTA tax rate starts at .8 percent, as shown above. In affected states, employers must pay .8 percent plus an additional .3 percent, for a total of 1.1 percent.
$7,000 times .011 equals $77 per employee per year. This is $21 more than employers in unaffected states will pay per employee for that time period. Let’s look at an employee who was hired in July and earned at least $7,000 before the end of the year. For that employee, employers in affected states would pay the regular FUTA tax rate of .6 percent, plus an additional .3 percent, for a total of .9 percent.
$7,000 times .09 percent equals $63 per employee per year. Again, this is $21 more than employers in unaffected states will pay per employee for the same time period. Which States and Territories Are Affected?
They are Arkansas, California, Connecticut, Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Virginia, Virgin Islands, and Wisconsin.
In addition, the state of Indiana is in its second year of credit reduction (now subject to the regular FUTA tax plus .3 percent for 2010 and another .3 percent for 2011), and the state of Michigan is in its third year of credit reduction (now subject to FUTA tax plus .3 percent for 2009, plus .3 percent for 2010, plus .3 percent for 2011).
The states of Alabama and South Carolina also took federal loans but have now met the requirements to avoid the credit reduction for 2011.
What is the FUTA Outlook for 2012?
The FUTA tax rate is expected to remain at .6 percent of wages up to $7,000 per employee. Employers that are in states currently subject to a credit reduction can expect FUTA to rise again by another .3 percent, unless the state is able to repay the loan or take other actions specified by federal law to avoid this penalty.
If you have questions about FUTA, consult with your payroll or tax adviser for more information.