Form 940 Explained: How FUTA Tax Works for Small Employers
If you pay employees, you probably know about Form 941 for quarterly payroll taxes. Form 940 is its annual cousin: the return for federal unemployment tax, better known as FUTA. It is paid only by the employer, never withheld from an employee's pay, and for most small businesses it comes to a modest amount per employee. Here is how it works.
What FUTA tax is
The Federal Unemployment Tax Act funds the federal share of unemployment benefits. Employers pay FUTA tax on the wages they pay, and report it once a year on Form 940. Employees do not pay FUTA, so it never appears as a deduction on a pay stub.
Who has to file Form 940
Most employers must file Form 940 if, in the current or previous year, either:
- they paid $1,500 or more in wages in any calendar quarter, or
- they had at least one employee for some part of a day in 20 or more different weeks.
Household employers (for example, paying a nanny) and agricultural employers have different thresholds, and household employers usually report FUTA on Schedule H with their personal return instead.
How FUTA tax is calculated
The FUTA rate is 6.0% on the first $7,000 paid to each employee in the year. That $7,000 is called the FUTA wage base.
Employers that pay their state unemployment tax in full and on time usually get a credit of up to 5.4%, which brings the effective rate down to 0.6%. That works out to at most $42 per employee per year (0.6% × $7,000).
The credit can be smaller if your state has borrowed from the federal government to pay unemployment benefits and has not repaid it. These are called credit reduction states, and the IRS publishes the list each year. If you paid wages in one, you complete Schedule A and pay a little more.
A worked example
A small business pays three employees during the year:
| Employee | Wages for the year | Wages over $7,000 |
|---|---|---|
| A | $48,000 | $41,000 |
| B | $30,000 | $23,000 |
| C | $5,000 | $0 |
| Total | $83,000 | $64,000 |
- Line 3, total payments: $83,000
- Line 5, payments over $7,000 per employee: $64,000
- Line 7, taxable FUTA wages: $83,000 − $64,000 = $19,000
- Line 8, FUTA tax (× 0.6%): $114.00
Employee C only earned $5,000, so all of their pay is taxable. Employees A and B are capped at $7,000 each.
When to deposit FUTA tax
You don't always pay FUTA once a year. Work out your FUTA tax at the end of each quarter:
- If the amount owed for the quarter (plus any amount carried forward) is more than $500, deposit it by the last day of the month after the quarter ends.
- If it is $500 or less, carry it forward to the next quarter.
Deposits are made electronically, for example through EFTPS. Many small employers with only a few staff never go over $500 and simply pay with the return.
When Form 940 is due
Form 940 for a year is due by January 31 of the following year. If you deposited all of your FUTA tax on time, you get until February 10.
Common mistakes
- Forgetting the $7,000 cap. FUTA is only charged on the first $7,000 per employee, not on all wages.
- Counting exempt payments as taxable. Some payments, such as certain retirement plan contributions and some fringe benefits, are exempt from FUTA and go on line 4.
- Missing a credit reduction. Check the IRS list if you paid wages in more than one state.
- Mixing up Form 940 and 941. Form 941 covers income tax withholding, Social Security and Medicare each quarter. Form 940 covers only FUTA, once a year.
Prepare Form 940 for free
Our free Form 940 generator works out taxable FUTA wages, the 0.6% tax, adjustments and your balance due as you type, and lets you download a PDF to check your numbers. For your quarterly return, see our Form 941 generator, and keep each payday documented with a pay stub.
This article is general information, not tax advice. Check the current IRS instructions for Form 940 or ask a tax professional about your situation.