On September 29, 2014, the Labor Department said it delayed the announcement on Federal Unemployment Tax Act credit reduction relief for states by several weeks due to a heavy caseload. Several states, including California, submitted fifth-year waiver applications, which can allow states to avoid additional credit reductions that further increase their tax burden. The Labor Department is expected to announce the states that will have credit reductions for 2014 and the reduction percentages around November 10.
What is the FUTA Tax?
The Federal Unemployment Tax Act (FUTA) tax is a federal tax on employers covered by a state’s unemployment insurance program. The standard FUTA tax rate is 6.0 percent on the first $7,000 of wages subject to FUTA per employee, and FUTA taxes go into the Federal Unemployment Trust Fund administered by the United States Department of Labor (DOL).
Employers generally receive a credit of 5.4 percent when they file their Form 940 reporting wages paid and figuring the FUTA responsibility. The Form 940 is the Employer’s Annual Federal Unemployment (FUTA) Tax Return. Filing the 940 normally results in a net FUTA tax rate of 0.6% (6.0% – 5.4% = 0.6%).
Some states take Federal Unemployment Trust Fund loans from the federal government if they lack the funds to pay unemployment insurance benefits for residents of their states. When states do this, but don’t repay the loans within the allowable time frame, they become credit reduction states because a reduction in the usual credit against the full FUTA tax rate is imposed, resulting in a greater amount of tax owed. FUTA tax credit reductions reported on Form 940 must be paid in January.
FUTA Credit Reduction Impact on Employers
Employers in credit reduction states have a higher tax due on Form 940. Employers in states with a credit reduction of 0.3 percent have an effective FUTA tax rate of 0.9 percent for the year because they reduce the 6.0 percent FUTA tax rate by only 5.1 percent instead of the normal 5.4 percent. The result is a higher rate.
In 2013, the FUTA credit reduction in California was 0.9 percent and increased the tax to $105 per employee. California’s unemployment insurance deficit reached into the billions.
The Labor Department will announce the total FUTA credit reductions that apply for 2014 on Nov. 10 and the Internal Revenue Service will confirm the credit-reduction percentages on Schedule A of Form 940, typically released in November or December.
FUTA costs for 2014 will reach record highs for credit-reduction states because it’s the first year an additional assessment will be added, the Benefit-Cost Ratio (BCR) add-on. This add-on potentially kicks in for states that have 5 consecutive years with unpaid balances to the feds (“fifth year”). Employers in some states in 2014 may be assessed more than five times the amount of federal unemployment tax that would apply if they didn’t have FUTA credit reductions. States thus affected can seek relief through waiver applications for the BCR add-ons to avoid the significant tax increase the add-on would impose. For 2014, “fifth-year” waiver applications were submitted by California, Indiana, Kentucky, New York, North Carolina, Ohio and Rhode Island.
Employers will know in early November what their FUTA credit reductions will be and if their states’ waivers are approved (if they applied) so that they can prepare for their January payments.
If you have any questions on how the FUTA Credit reduction will impact your company, contact our specialists at PAYDAY for all of the answers.