FUTA

The Federal Unemployment Tax Act (FUTA) is a United States federal law that mandates employers to pay a payroll tax, used to fund state workforce agencies and provide unemployment compensation to eligible workers who have lost their jobs. FUTA ensures a cooperative federal-state system of unemployment insurance (UI) that supports workers during periods of involuntary unemployment.

FUTA tax is paid only by employers; it is not withheld from employees’ wages. The standard FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee annually. However, employers typically receive a credit of up to 5.4% for paying state unemployment taxes on time, reducing the net federal rate to 0.6%.

Key Form: IRS Form 940, the Employer’s Annual Federal Unemployment (FUTA) Tax Return, is used to report and pay FUTA taxes.

State Unemployment Tax Systems (SUTA or SUI)

In addition to the federal FUTA tax, state unemployment taxes (commonly called SUTA, or State Unemployment Insurance (SUI)) are required in all U.S. states. These taxes are assessed by each state to support its own unemployment benefits program.

Each state sets:

• Its own wage base (the amount of wages subject to tax)
• The tax rate (which may vary based on the employer’s experience rating)
• Employer registration requirements

Federal and state systems work together, but they are separate. Employers must comply with both. The U.S. Department of Labor provides a list of State UI Tax Agencies for employer assistance.

Who Pays FUTA?

FUTA is an employer-only tax, which means that:

• Employees do not pay FUTA taxes or see any deductions from their paychecks.
• Employers calculate and pay this tax based on gross wages paid to each employee up to the wage base limit.

FUTA applies to most employers who:

• Pay $1,500 or more in wages in any calendar quarter in the current or previous year, or
• Have one or more employees working at least part of a day in any 20 different calendar weeks during the year.

U.S. Citizens and Resident Aliens Employed Abroad – FUTA

Wages paid to U.S. citizens or resident aliens working outside the United States are not subject to FUTA tax if they are employed by an American employer under certain conditions.

Exceptions may include:

• Employment under a U.S. government contract or with a U.S. firm abroad
• The presence of a tax treaty or bilateral agreement affecting unemployment insurance responsibilities

Employers should carefully assess whether FUTA applies based on:

• The location of services
• The employer’s residency and structure
• Any relevant international agreements

Aliens Employed in the U.S. – FUTA

Wages paid to noncitizens (aliens) working within the U.S. are generally subject to FUTA, provided all the normal conditions are met. It does not matter if the employee is a permanent resident, visa holder, or temporary worker—so long as:

• They perform services within U.S. jurisdiction
• The employer-employee relationship exists

FUTA coverage applies unless a specific exemption under tax law exists (e.g., student employees, family employees under certain conditions).

Persons Employed in U.S. Possessions – FUTA

Special considerations apply to U.S. territories and possessions, such as:

• Puerto Rico
• Guam
• American Samoa
• U.S. Virgin Islands
• Northern Mariana Islands
  

If an employer is located in or pays wages for services performed in a possession that operates its own unemployment system, those wages may not be subject to FUTA, but may still be subject to a territorial unemployment tax.

Employers should determine:

• Whether the territory has a certified UI program
• Whether the services performed qualify for FUTA exemption

Persons Employed by a Foreign Employer – FUTA

If a foreign company (not registered in the U.S.) employs someone within the United States, FUTA may still apply if:

• The services are performed within the U.S.
• The foreign entity has an established U.S. presence or office
• There is an employer-employee relationship governed by U.S. law

However, if the employer is fully foreign and lacks a U.S. business connection, FUTA may not apply. It’s essential to consult with tax professionals to determine liability.

Note: U.S. affiliates of foreign companies are generally subject to FUTA when hiring domestic employees.

Persons Employed by a Foreign Government or International Organization – FUTA

Employment by foreign governments or recognized international organizations (e.g., United Nations, World Bank, IMF) is typically exempt from FUTA.

These exemptions exist because:

• Foreign governments enjoy sovereign immunity
• International organizations are often governed by treaties that exempt them from U.S. taxation and labor laws

However, if the organization is registered and conducts business activities in the U.S., and the employment is deemed commercial, exemptions may not apply. It’s advisable to consult international employment and tax experts in these scenarios.

Nonresident Alien (NRA) Withholding and FUTA

Nonresident aliens (NRAs) working in the U.S. may or may not be subject to FUTA, depending on:

• Their visa type (e.g., F-1, J-1, H-1B, O-1, etc.)
• Their tax residency status under the substantial presence test
• Whether their services are classified as employment

Typically

• F-1, J-1, M-1, Q-1 visa holders engaged in practical training are exempt from FUTA
• NRAs who are employees under a standard work visa (e.g., H-1B) are subject to FUTA, just like U.S. citizens

Important Distinction: NRA income may be subject to federal income tax withholding, but that is separate from FUTA.

IRS Form 940 – Employer’s Annual FUTA Return

Employers must file Form 940 annually to report FUTA taxes. Key details include:

• Total wages paid to employees
• Exempt wages (such as fringe benefits, group-term life insurance, or retirement contributions)
• Adjusted FUTA tax based on allowable credits for state unemployment taxes

Filing deadline: January 31 of the following year
Employers who deposit FUTA taxes on time may have an extended filing deadline of February 10

FUTA Exemptions Summary Table

Why FUTA Matters to Employers

FUTA is more than a tax obligation—it affects:

• Eligibility for unemployment benefits for terminated workers
• Employer financial planning, as unemployment insurance rates can increase based on claim history
• Compliance risk, since late deposits or incorrect filings result in IRS penalties

Understanding FUTA also helps employers navigate:

• Multistate workforce management
• International employment compliance
• Global mobility strategy for expatriates and inbound talent

FUTA and Payroll Systems

Modern payroll systems automatically calculate and withhold appropriate taxes, including FUTA. However:

• Employers must verify exemption statuses (e.g., students, foreign hires)
• Manual overrides may be necessary when unusual employment categories arise

Employers are advised to regularly audit payroll settings and consult the latest IRS guidance to ensure ongoing compliance.

Conclusion

The Federal Unemployment Tax Act (FUTA) plays a critical role in supporting the U.S. unemployment insurance system. Although the tax is relatively low and employer-only, the nuances of its applicability—especially in cases involving foreign workers, international assignments, or nonresident aliens—make compliance a high-stakes issue.

Understanding these distinctions enables employers to:

• Correctly apply tax withholding
• Avoid penalties
• Support employees’ access to unemployment benefits where applicable

For further guidance, always consult the most current IRS Form 940 Instructions and state UI tax authorities.