The Federal Unemployment Tax Act (FUTA) imposes a tax on employers based on the compensation paid to employees. It is important to remember that this tax is NOT deducted from employee’s wages, but is an employer only tax. It is also important to note that the FUTA tax is not used to pay actual unemployment benefits, but to administer both the federal and state unemployment programs. Actual unemployment benefits are paid based on each state’s unemployment compensation laws. If you are a business owner, you know firsthand that the current economy has put great strain on the unemployment compensation system and that your corresponding rates have probably increased as a result of this strain.
For purposes of deeming if one is an employer, you must meet either of these two tests:
- Pay wages in excess of $1,500 during any calendar quarter in the current or previous calendar year, or
- One of more persons is in your employ, on at least some portion of the day, in each of the 20 or more calendar weeks during the current or previous calendar (taxable) year.
There are some other rules based on agricultural and household employers, but the overwhelming majority will be determined via the two tests above. Once you are deemed an employer, you would continue to be so until you fail to meet either of the two tests for coverage during the year. In general, when looking at state unemployment taxes (SUTA), the same test applies as to whether you are an employer or not. However, there are varying regulations from state to state, and it is your responsibility to know the laws where you might incur a SUTA obligation. A great site for more information is http://www.servicelocator.org/OWSLinks.asp which has a great deal of information and interactive links on individual states’ unemployment related issues.
As mentioned, the definition of an employee under FUTA is generally applicable to the determination of employee status under state (SUTA) coverage. A conundrum exists, however, where an employee may be an interstate employee—i.e. an employee who works in more than one state. In order to eliminate having duplicate SUTA contributions on interstate employees, most states have adopted a four-part definition on which state will cover the employee:
- Place where work is localized—if the work is mainly performed in one state then the work is localized to that state and is covered as employment under the law of that state.
- Base of operations location—the location of the base of operations where an employee customarily begins work and returns to after work. The base of operations is usually where business records are maintained, the employee receives instructions, or office is maintained (which can be the employee’s home).
- Operations directed and controlled—if an employee can perform functions across any number of states, if operations are directed and controlled from a state in which some functions are performed, this would be the state that covers the employee.
- Employee’s residence state—if none of the other three tests can be reliably applied, the employee’s residence state is used provided that some of the employee’s functions are performed in that state.
There are also situations where an employee’s coverage state cannot be determined from the aforementioned tests. In this case, many states have what is called a reciprocity agreement to provide unemployment benefits to interstate workers. Most states follow the Interstate Reciprocal Coverage Arrangement and allow the employer to cover a worker in a single state where the employee performs work, employer maintains a business, or the employee maintains a residence. In general terms, the interstate employee should consent to the state selection as well as the state agencies involved.
Now that we have covered the basics of who is an employer and how to select the state for an employee’s SUTA coverage, you must determine the taxable wages and how to actually calculate FUTA/SUTA on those wages. You also have credits against the FUTA tax based on contributions made to state unemployment compensation. To further complicate matters, states can assign an experience factor based on the stability of employment an employer provides. This experience factor is lowered as an employer has lower turnover. We will cover these topics next week as well as discuss the Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.