The Federal Unemployment Tax Act (FUTA) imposes a payroll tax on employers, based on the wages they pay to their employees. You don't withhold the FUTA tax from an employee's wages; the business itself must pay this tax.
Liability for tax. You must pay the FUTA tax if during the current or the preceding calendar year you meet either of the following tests:
Once you meet either of the tests, you become liable for the FUTA tax for the entire calendar year and for the next calendar year as well. For example, if you first met the 1-in-20 test in December 2001, you would have been responsible for the tax with respect to the wages you paid during the entire 2001 calendar year as opposed to just the wages you paid after you met the test. You would also continue to be liable for the FUTA tax during the 2002 calendar year, even if you fail to meet both the wages-paid test and the 1-in-20 test during that year.
Computing the tax. The FUTA tax is imposed at a single flat rate on the first $7,000 of wages that you pay each employee. Once an employee's wages for the calendar year exceed $7,000, you have no further FUTA liability for that employee for the year.
The FUTA tax rate is a flat 6.2 percent. However, you can generally claim credits against your gross FUTA tax to reflect the state unemployment taxes you pay. If you paid all your state unemployment taxes on time, and before the due date of your FUTA tax return, you'll be allowed to claim a credit equal to 5.4 percent of your federally taxable wages. This will effectively reduce the FUTA tax rate to 0.8 percent. The fact that your actual state tax rate is far below 5.4 percent doesn't matter — the federal credit is fixed at that rate.
The FUTA tax is scheduled to decrease to 6.0 percent, which means an effective rate of 0.6 percent, effective January 1, 2008. However, this decrease has been postponed in the past and may well be postponed in the future.