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Unemployment Taxes: What you need to know

Making sure you know about Federal and State assistance for unemployment should be on the top of your list

Written By: CompuPay, Inc.

In 1935, Congress enacted the Social Security Act which contained provisions designed to establish unemployment insurance to compensate workers during times of temporary unemployment. The program is a joint federal and state venture funded in all 50 states through the Federal Unemployment Tax Act (FUTA) and the State Unemployment Tax Authority (SUTA). Both FUTA and SUTA are paid by the employer only and benefits are designed to be paid to workers who are unemployed through no fault of their own.

Federal and State Responsibilities
Because it is a cooperative effort between federal and state governments, in order for the program to work effectively, federal and state unemployment agencies each have specific responsibilities:

States have direct responsibility for establishing and operating their own unemployment insurance programs within the guidelines of federal law. State unemployment program funds are used for the sole purpose of making the actual benefit payments to unemployed individuals. State law determines the individual state unemployment insurance tax rate.

The federal unemployment program has no provision for payments of benefits directly to the unemployed. Federal unemployment funds are used for three reasons exclusively:

  1.  To finance expenses deemed necessary for proper administration of unemployment programs.
  2. Funding of extended benefits, i.e. the unemployment benefits paid to eligible employees beyond the state's typical maximum.
  3. Loans to states. States may borrow from the federal government when their In 1935, Congress enacted the Social Security Act which contained provisions designed to establish unemployment insurance to compensate workers during times of temporary unemployment.

Benefits for Workers
Monetary benefits of unemployment insurance are based on the employee's base period. The base period is defined by the employee's earnings from employment over a prior reference period, which in most states is the first four of the last five completed calendar quarters.

Benefits are paid to the unemployed for a maximum of 26 weeks in most states. Extended benefits may be available during times of high unemployment or for specific purposes and provide for up to an additional 13 weeks of benefits to qualified workers. All benefits are subject to federal income tax and must be reported on the individual's federal income tax return.

Worker Eligibility
All states require that, in order to receive benefits, unemployed workers must be able and available to work. Workers must be unemployed through no fault of their own due to lack of work and must be in the labor force actively seeking employment. Although registration for work through a state public employment office is considered a good way for unemployed workers to provide evidence of their ability and willingness to work, most state agencies require that the unemployed make independent job seeking efforts as well.

Calculating FUTA
Employers required to pay FUTA must calculate the amount due by multiplying the first $7,000 of wages paid to each employee during a calendar year by 6.2 percent. Typically, employers who pay SUTA on a timely basis receive a FUTA tax credit of up to 5.4 percent, regardless of the rate of tax paid to the state, making the effective FUTA rate equal to 0.8%. FUTA is reported annually on IRS Form 940 by employers and paid either quarterly or annually.

Reduced FUTA Tax Credit 
During periods of high unemployment, state unemployment benefits funding may become depleted and states can borrow money through federal loans to continue supporting the program. When a state has unpaid federal loans for a period of two or more years, federal law provides for a reduction in the FUTA tax credit in order to collect money owed. The tax credit reduction is 0.3% in the first year and an additional 0.3% in all years following until the state has repaid its loan.

In the current economic downturn, extended periods of high unemployment have caused many states to borrow from the federal government to continue funding unemployment benefits. As the loans exceed the two year period, employers in those states are subject to the reduced FUTA credit, and therefore pay a larger FUTA tax amount. The state of Michigan has been the first to see a reduction in the FUTA tax credit. However, the number of states and the percentage of credit reduction are projected to increase and employers in affected states should expect to feel the impact of reduced FUTA credit over the next few years.

Visit or your state's Web site for more information regarding changes to FUTA credit.

CompuPay is one of the leading payroll, tax filing and HR-related service providers in the country. Since 1980, we have established relationships with thousands off accounting professionals, allowing them to better attract, serve and retain business clients.  CompuPay is not a tax advisor and makes no claims as such. Please consult your tax advisor for additional information.


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