As most employers are aware, the Federal Unemployment Tax Act (FUTA) is a federal tax levied on employers covered by the Unemployment Insurance (UI) program, at a current rate of 6.0% on wages up to $7000 a year paid to a worker. The law, however, provides a credit against the federal tax liability of up to 5.4% to employers who pay state taxes timely under an approved state UI program. When states meet the specified requirements, employers pay an effective federal tax of 0.6%, or a maximum of $42 per covered worker, per year.
When states lack the funds to pay UI benefits, they may obtain loans from the federal government. To assure that these loans are repaid the federal government is entitled to recover those monies by reducing the FUTA credit it gives to employees, which equates to an overall increase in the FUTA tax. Such an increase is referred to as a credit reduction because the 5.40% credit for state UI taxes paid is reduced.
Given enough time, the credit reductions could theoretically cause an employer’s net FUTA tax rate to increase from 0.60% all the way to 6.00% as the credit is gradually reduced to zero. The tax revenue generated by the credit reductions is credited to the state’s UI trust fund that reduces the state’s loan balance.
When a state has an outstanding loan balance on January 1 for two consecutive years, and the full amount of the loan is not repaid by November 10th of the second year, the FUTA credit of 0.60% will be reduced until the loan is repaid. The reduction schedule is 0.3% (on a $7000 taxable wage base) for the first year and an additional 0.3% for each succeeding year until the loan is repaid. From the third year onward, there may be additional reductions in the FUTA tax credit, commonly dubbed add-ons.
For 2013, employers in 13 states, including the Virgin Islands (down from 18 states in 2012) experienced FUTA credit reductions (i.e. tax increases). Most of these states will not repay their federal loans in time to avoid a credit reduction for 2014, which will be greater than the credit reduction for 2013. For example, the net FUTA tax rate for California employers will most likely increase from 1.5% to 1.8% because the credit reduction will most likely also increase from 0.90% to 1.20%.
The federal unemployment tax rate for employers has become a moving target, making budgeting for this expense more difficult. The budgeting problem is exacerbated by the fact that state UI agencies have until November 10th to repay their long-term loan and avoid a credit reduction for the calendar year in which the loan balance is repaid. No official notification of credit reductions is provided until after November 30th. By that time employers have already submitted three quarterly FUTA deposits and any shortfall must be paid with the final deposit for the calendar year (due January 31st of the succeeding year).
The below chart shows you the pattern of the past 5 years FUTA credit reductions. This is the best budgeting tool available, but you should bear in mind that any of these at-risk states may repay their loan by November 10, 2014, and any states that previously did not have a credit reduction for 2013 could have one for 2014.
