FUTA Credit Reduction
SCOTT MEZISTRANO: Hello, everyone.
I'm Scott Mezistrano, CPP, a Program Analyst with IRS' Employment Tax Policy.
Today, we'll be talking about the Federal Unemployment Tax Act, or FUTA, credit reduction.
Our discussion will include a brief explanation of what the credit reduction is, the tax effect of the credit reduction, and how to report the credit reduction.
In addition to the FUTA credit reduction, we'll discuss when you will need the new Form 8822-B.
Here's the background.
The Federal Unemployment Tax Act provides for cooperation between the federal and state governments in the establishment and administration of a federal-state unemployment compensation program.
Under this dual system, the federal and state governments levy payroll taxes against employers.
The standard federal tax rate is 6% on the first $7,000 of wages subject to FUTA.
But employers that pay their state unemployment insurance in full and on time get a credit back from the federal government of 5.4% when they file their Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return.
This results in a net FUTA tax rate of 0.6%.
However, some states have taken Federal Unemployment Trust Fund loans from the federal government.
They did this because they lacked the funds to pay unemployment insurance benefits to the recipients in their states.
The Department of Labor, or DOL, runs the loan program.
Now, if a state has outstanding loan balances on January 1st for two consecutive years and it does not repay the full amount of its loans by November 10th of the second year, it is considered a credit reduction state.
An employer in a credit reduction state must reduce the 5.4% FUTA credit rate for FUTA taxable wages in that state until the state repays the loan.
The credit reduction schedule is 0.3% for the first year that the state is a credit reduction state and an additional 0.3% for each year thereafter that the state has not repaid its loan in full to the DOL.
In a state with a 0.3% credit reduction, the maximum credit an employer could receive on the FUTA tax for wages in that state is 5.1%.
This is in contrast to the 5.4% credit on the FUTA tax for wages paid in a state that is not a credit reduction state.
DOL announces any credit reduction states each year after the November 10th deadline.
You can find the specifics on the DOL Website on its "UI Statistics" page.
So how does this credit reduction affect an employer's taxes?
The credit reduction results in a higher tax due on the Form 940.
For example, an employer in a state with a credit reduction of 0.3% would compute its FUTA tax by reducing the 6% FUTA tax rate by a FUTA credit of only 5.1%, which is the standard 5.4% credit minus the 0.3% credit reduction.
This would give an effective FUTA tax rate of 0.9% for the year.
In states that are not subject to credit reduction, the effective FUTA tax rate remains 0.6%.
If the state's loan balances remain unpaid for another year, the FUTA credit is further reduced by another 0.3%, from 5.1% to 4.8%.
Accordingly, the effective FUTA tax rate for FUTA wages in that state increases from 0.9% to 1.2%.
As you can see, this rate increases by 0.3% for each additional year the state fails to repay its UI loans.
Any increased FUTA tax liability due to a credit reduction is considered a liability incurred in the fourth quarter.
The increased tax liability is due by January 31st of the following year.
It is important for employers with employment in a credit reduction state to plan accordingly for the lower credit and increased FUTA obligations.
The IRS includes the credit reduction states, the applicable credit reduction rates, and an example in the Form 940 Schedule A, Multi-State Employer and Credit Reduction Information.
The Instructions for Form 940 also have information about the credit reduction and deposit rules.
Now we need to talk about how to report the FUTA credit reduction.
Form 940 Schedule A was revised in 2011 to allow for the growth in the number of credit reduction states and for the calculation of the increased FUTA tax liability.
On Form 940 Schedule A, every state has a checkbox - to be checked if an employer paid state unemployment taxes to that state - and a box for the FUTA taxable wages the employer paid in any credit reduction state.
The following employers use the Form 940 Schedule A - employers that paid state unemployment tax in more than one state and employers that paid FUTA taxable wages in any credit reduction state, even if the employer is a single-state employer.
These employers report the FUTA taxable wages and multiply by the credit reduction rate - 0.3%, 0.6%, et cetera - to calculate the total credit reduction, which the employer then carries forward to Form 940.
Remember, if an employer paid UI taxes to more than one state, it must check the boxes for all of those states on Form 940 Schedule A, whether or not they are credit reduction states.
For any credit reduction states, an employer must enter the FUTA taxable wages it paid in that state, even if it paid wages in only that one state.
Finally, moving away from Form 940, here's something new.
Beginning in 2012, employers must use the new Form 8822-B, Change of Address - Business, for any address changes.
So don't forget to let us know your or your client's new location.
If you need more information about the FUTA credit reduction, an employer's change of address, or any other tax issue, be sure to check IRS.gov.
I hope you found this information useful, and I thank you for your time and attention.