Running a business feels like death by a thousand paper cuts, especially when the IRS starts knocking. You’ve got your income tax, your Social Security, your Medicare, and then there is that one lingering line item that everyone forgets until January: the FUTA tax. Honestly, if you’re looking to pay federal unemployment tax, you’re probably already knee-deep in Form 940 and wondering why on earth you’re paying for a system that you hope your employees never actually have to use.
It’s a weird tax. Unlike the taxes taken out of a paycheck, this one is all on you. Your employees don’t pay a dime toward it. You can't deduct it from their wages. It's 100% a "cost of doing business" expense that funds the oversight of unemployment insurance programs at both the federal and state levels.
The 6% Myth and the Credit That Actually Matters
If you look at the IRS website, the headline rate to pay federal unemployment tax is 6.0%. That sounds high. If you have ten employees making $40,000 a year, 6% would be a massive hit to your cash flow. But wait. There's a massive "but" here.
Most employers end up paying a net rate of only 0.6%.
How? It’s the FUTA tax credit. Because you also pay state unemployment insurance (SUI or SUTA), the feds give you a break. They figure you’re already doing the heavy lifting at the state level, so they let you take a credit of up to 5.4% against the federal rate. 6.0 minus 5.4 equals 0.6. That is the math that keeps most small business owners from losing their minds.
However, this isn't a guarantee. If your state is in the "doghouse" with the federal government because they borrowed money to pay out unemployment benefits and haven't paid it back, you might deal with a "credit reduction." This happens more than you'd think. States like California, New York, and Connecticut have historically struggled with this. When a state has a credit reduction, your 0.6% rate might suddenly climb to 0.9% or 1.2%. It doesn't sound like much until you're looking at your year-end balance sheet.
The $7,000 Ceiling
Here is the kicker: you only pay federal unemployment tax on the first $7,000 you pay to each employee in a calendar year.
Once an employee hits $7,001 in earnings, you stop paying FUTA for them for the rest of the year. This makes the tax highly "front-loaded." In the first quarter of the year, your tax bill feels heavy. By October, if your staff is stable, you’re likely paying nothing at all. This creates a weird incentive for seasonal businesses, but for most professional services, it’s just a quirk of the payroll calendar.
If you hire a new person in July, the clock resets for that specific individual. Even if they earned $50,000 at their previous job that year, you start from zero on their FUTA calculation. It’s annoying. You’re essentially double-paying the tax for that "seat" in your company, but the IRS doesn't care who the person worked for before; they care about who is paying them now.
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When Do You Actually Send the Money?
Don't think you can just wait until you file your annual return to pay. The IRS wants its cut throughout the year.
The rule is simple but easy to trip over: if your FUTA tax liability exceeds $500 in any given quarter, you have to deposit it. If it's under $500, you can carry it over to the next quarter. If you stay under $500 for the whole year, you can just pay it when you file Form 940.
Most small businesses with just one or two employees might only pay once a year. But if you have five or six people, you'll hit that $500 threshold in the first quarter easily.
How to Deposit
You have to use the Electronic Federal Tax Payment System (EFTPS). Do not try to mail a check. The IRS has largely moved away from paper for these types of business deposits. If you're using a payroll service like Gusto, ADP, or Quickbooks Payroll, they usually handle this for you. They pull the money out of your account every time you run payroll and hold it until the deposit deadline. It’s cleaner that way, honestly.
If you’re doing it yourself, you need to be disciplined. Missing a deposit deadline results in penalties that can reach up to 10% of the amount due. That's a lot of money to lose just because you forgot to click a button on a Tuesday.
Common Mistakes That Trigger Audits
The IRS isn't always looking for the "big fish." Sometimes they just look for math that doesn't add up. One of the biggest red flags when you pay federal unemployment tax is a discrepancy between your Form 940 (annual) and your Forms 941 (quarterly).
Form 941 tracks Social Security and Medicare. Form 940 tracks FUTA. If the total wages reported on your 941s for the year don't match the total wages on your 940, the IRS computers will flag it. It’s an automated process. You'll get a letter—usually Letter CP161 or something similar—asking why the numbers don't dance together.
Another trap is the "Independent Contractor" vs. "Employee" debate.
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If you’re paying people via 1099, you don’t pay FUTA. Some owners try to be "clever" and misclassify employees as contractors to avoid the 0.6% tax. Don't. The Department of Labor and the IRS have cracked down on this significantly in the last few years. The cost of a misclassification audit—including back taxes, interest, and legal fees—will dwarf whatever you saved by not paying $42 per employee per year (which is the 0.6% of $7,000).
The State Connection (SUTA vs FUTA)
You cannot understand how to pay federal unemployment tax without looking at your state obligations. The two systems are tethered.
Every state has its own wage base. While the federal wage base is a static $7,000, states vary wildly. In Washington state, the wage base can be over $60,000. In others, it stays close to the federal level.
If you are late paying your state unemployment tax, the IRS can actually revoke part of that 5.4% credit. This is the ultimate "double whammy." You pay a penalty to the state for being late, and then the IRS charges you a higher federal rate because you weren't "in good standing" with the state. It’s brutal.
Exemptions You Might Not Know About
Not every payment to an employee is subject to FUTA.
- Retirement contributions: Employer contributions to a 401(k) are typically exempt.
- Health insurance: If you're paying for your team's premiums, that money isn't taxed for FUTA.
- Family members: This is a big one. If your business is a sole proprietorship and you hire your child who is under 21, you don't have to pay FUTA on their wages. The same applies to a spouse in many cases.
This "family business" exemption is a legitimate way to keep costs down, but it only works if the business structure is right. If you’re an S-Corp, these exemptions usually disappear because the "employer" is the corporation, not the individual parent or spouse.
Dealing with Form 940
Form 940 is the "Employer's Annual Federal Unemployment (FUTA) Tax Return." It’s due by January 31st of the following year. However, if you've made all your deposits on time throughout the year, the IRS gives you an extra ten days—until February 10th—to actually file the paperwork.
The form itself is two pages of bureaucratic joy. You'll need to know:
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- Your total payments to all employees.
- Payments exempt from FUTA.
- Total payments over $7,000.
- The specific states where you paid unemployment tax.
If you operated in multiple states, you have to fill out Schedule A. This happens a lot with remote work now. If you have one guy in Austin and another in Nashville, you’re a multi-state employer. You have to allocate the wages correctly or the credit calculations will be a nightmare.
Practical Steps to Stay Compliant
Stop thinking about FUTA as a once-a-year headache. If you want to pay federal unemployment tax without the stress, you need a system.
First, check your state's "Credit Reduction" status. The Department of Labor publishes a list every November. If your state is on it, manually adjust your tax set-asides for the final quarter so you aren't surprised by a higher bill in January.
Second, reconcile your payroll every single quarter. Don't wait until December. Compare your total gross payroll to the FUTA-taxable portion. If you see an employee who has earned $15,000 but you're still accruing FUTA for them, your software is broken. Fix it now.
Third, if you’re a new business, register with your state's unemployment agency immediately. You cannot get the 5.4% federal credit without a state account number. If you file your federal 940 without a state ID, the IRS will assume you paid 0% to the state and bill you for the full 6.0%. That is a massive difference—$420 per employee versus $42 per employee.
Finally, keep your records for at least four years. The IRS can go back that far to verify your FUTA filings. This includes copies of your 940s, records of your deposits, and proof of your payments to the state unemployment fund.
Actionable Next Steps for Business Owners
- Verify your 2025/2026 status: Log into your EFTPS account and ensure your Q4 2025 deposits were recorded correctly before you file the annual Form 940.
- Audit your "Family Hires": If you are a sole proprietor or a husband-wife partnership, ensure you aren't overpaying FUTA on your own children’s wages if they are under 21.
- Review State ID Numbers: Ensure your payroll provider has the correct State Unemployment Insurance (SUI) ID for every state where you have employees. A missing ID is the #1 cause of "missing credit" notices from the IRS.
- Check for Credit Reductions: Search the Department of Labor’s "FUTA Credit Reduction" list to see if your state’s employers are being penalized this year. Adjust your January budget accordingly.
The complexity of FUTA isn't in the rate—it's in the credits and the timing. Stay on top of the $7,000 cap and keep your state payments current, and you'll find that paying this tax is one of the smaller hurdles in your business journey.