Last week we covered the basics of FUTA and SUTA including the unemployment obligations, determination of the SUTA state, as well as reciprocity arrangements. This week we will look at the wages that are to be taxed for FUTA and SUTA, FUTA calculations and limits including credits against the FUTA tax, as well as the Form 1040, Employer’s Annual Federal Unemployment (FUTA) Tax Return. We will touch on SUTA as well, but with each state having its own rules and regulations, it would behoove you to consult qualified tax specialists for information on specific states.
Generally speaking, wages are defined as all remuneration for employment and work performed. As of this writing, only the first $7,000 of remuneration paid with respect to employment are taxable (FUTA) during a calendar year. It is irrelevant how the employee is paid—hourly, salary, piece work, or the frequency of said payments for taxability purposes. For SUTA purposes, the definition of wages is also fairly uniform and complies with the federal definition of wages as far as taxable wages. However, most states have differing limits on how much of the wages are taxed so you should make sure you use the proper limits in SUTA calculations.
The FUTA tax rate for 2012 is 6.0% on the first $7,000 of wages during the calendar year. While this is the gross FUTA tax rate, the actual FUTA tax paid is approximately .6% since employers are entitled to a credit for contributions made under state unemployment compensation laws. The maximum credit allowed is 5.4% provided your SUTA is paid in a timely manner. In the event your SUTA tax is less than 5.4%, you still get the maximum full credit against the FUTA tax. So, for example, in 2012 assume Susie Smith had wages of $50,000 of which the entire amount would be paid in 2012. Since the wages paid are in excess of $7,000 only the 1st $7,000 of Susie’s wages are subject to FUTA tax. Using our example, the gross FUTA tax would be $7,000 * 6% which is $420.00; however, note the emphasis on gross FUTA tax as this amount does not include the credits against the FUTA tax. Since Susie lives in a state that is eligible for FUTA credit reduction AND her employer has paid their unemployment taxes on time, you can subtract 5.4% from the FUTA rate, so the net FUTA tax due and payable would be $7,000 * .6% which would equal $42.00. Note in the previous sentence we mentioned ‘eligible for FUTA credit reduction’—with many states unemployment compensation funds depleted, they have had to take loans from the federal government. If these loans are not repaid within 2 years, employers lose part of the FUTA tax credit resulting in higher FUTA taxes on employers. As of this writing, the following states are subject to these additional FUTA taxes and your tax professional should be consulted accordingly:
Arkansas, California, Connecticut, Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Virginia, Virgin Islands, Wisconsin
Employers in these states should also plan for annual interest statements due to these outstanding loans. This interest is in effect for 2011 and future years; previously the interest on these federal loans was waived through 2010 due to the American Recovery and Reinvestment Act of 2009.
In some cases, employers may pay into their state unemployment compensation funds at rates lower than 5.4%. These contributions are lowered due to the employer providing stable and steady employment. The method these contributions are lowered is known as their experience rating or merit rating. An employer with a favorable employment record would pay a rate lower than the standard SUTA rate, however, they would still be eligible for the full FUTA credit against taxes paid. In this manner, employers with steady employment histories pay lower SUTA tax rates, whereas new employers or employers with a less favorable experience rating must pay the full SUTA tax rate. Of the formulas used to determine an employer’s tax contribution rate, the most commonly used is the reserve-ration formula:
Reserve Ratio = (SUTA Contributions – Unemployment Claims Paid) / Average Payroll
Employers who have built up a balance in their reserve account (taxes paid less benefits paid) are called positive-balance employers and pay lower SUTA rates where applicable. Employers who have more benefits paid than taxes paid are called negative balance employers and subsequently have higher (or standard) SUTA tax rates.
It is critical to also mention that The SUTA Dumping Prevention Act requires states to enact laws that prevent business with poor experience ratings from forming new companies with lower new employer tax rates and transferring employees to the new company. This practice is called SUTA dumping—i.e. ‘dumping’ the previous company’s higher tax rates for the lower ones of the new company. More states are investigating and enforcing this provision as it directly affects their state unemployment compensation funds.
As one can imagine, employers whom are liable for FUTA and SUTA taxes must file periodic reports with both federal and state governments. For FUTA tax reporting, employers use the Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return and usually makes quarterly tax payments. Completing the Form 940 is fairly straightforward and the IRS provides instructions and guidance for doing so. In the event you pay SUTA tax in more than one state, you must also complete and submit Schedule A to be included with your Form 940. You must file the annual return no later than January 31 following the close of the calendar year. If you have made timely deposits that pay your FUTA liability in full, you can delay filing the Form 940 until February 10.
Any employer who is liable for SUTA contributions must also submit a quarterly contribution report. This report provides a summary of wages paid during the period as well as the SUTA tax calculations and contribution. The report usually must be filed the last work day of the month following the close of the calendar quarter and the tax also paid at the same time. In most states you must also submit a wage information report with the quarterly contribution report that shows gross wages paid by employee/social security number and the number of credit weeks earned. A credit week is defined be the SUTA law, but usually means a week during the calendar quarter where a minimum remuneration was earned.
As you can see from our Payroll 101 posts, our country’s main social safety net (Social Security, Medicare, and Unemployment Compensation) is funded by payroll taxes of various types and rates. The biggest issue with unemployment compensation arises when, as an employer, you have employees in numerous states with their own rates, limits, and reporting requirements. Fortunately there are readily available sources of this information as well as the state unemployment offices are always quite happy to help you (as you can imagine). From this point, our future Payroll 101 posts will look at various payroll topics such as outsourcing and other payroll management topics, but may not be on a weekly basis. For our weekly topic over the next few weeks, we will be covering Worker’s Compensation 101, which, for many of our clients, is their second biggest expense next to payroll.