Employers have many roles when it comes to running their businesses, including managing employee taxes. As discussed in previous guides, small business owners have to pay various taxes like the FICA tax or Federal Insurance Contributions Act tax on behalf of their employees. These taxes fund a variety of programs from Social Security, Medicare, government projects, highways, schools, and unemployment compensation. Unemployment compensation is an important safety net that gives laid-off workers a source of income as they look for employment.
The Federal Unemployment Tax Act and the State Unemployment Tax Act (FUTA and SUTA, respectively) fund unemployment compensation and small business owners need to use Form 940 to report FUTA taxes. FUTA taxes are regulated on a federal basis while SUTA taxes are governed by each state. This guide will discuss these taxes in detail, form 940 instructions, timing, and other important resources.
What is Form 940?
Form 940 is a tax return used to report a small business owner’s FUTA tax liability throughout the calendar year. FUTA is different from FICA as employees don’t contribute towards this tax. Therefore, this tax isn’t reflected on an employee’s paycheck.
Fortunately, this form isn’t too complex as it’s only a few pages and comes with useful instructions. For instance, it tells employers how to calculate adjustment and shows which items are exempt from this tax.
Some items like Group Term Life Insurance (GTL), employer retirement plan and dependent care contributions are exempt from FUTA. These factors are clearly labeled on the first page under part 2 line 4. Also, it has an area that allows small business owners to identify quarterly payments paid throughout the year.
When to file Form 940?
Small business owners need to file this tax return if any of the below scenarios are true:
- They paid at least $1,500 to any W-2 employee
- The business had at least one part-time or full-time employee that worked 20 or more weeks throughout the year. Keep in mind that there is no hourly minimum for employees.
They must also file this form on a quarterly basis, similar to estimated federal tax payments. However, the deadlines are slightly different as FUTA and require small business owners to pay by the 30th of the month following the quarter. So, first quarter payments would be due on April 30th, provided the tax due was at least $500.
If the tax liability was $200 for quarter one and $400 for quarter two; the business will be required to pay $600 in quarter two. Businesses that have a FUTA tax of less than $500 throughout the year only have to pay when the form is filed on its final deadline of January 30th. However, if the small business owner paid all the tax in full, he or she would have an additional 10 days to file.
Most employers have to file form 940, but there are some exceptions to this rule, which are:
- Non-profits, religious organizations and other 501(c)(3) accredited firms are exempt from paying this tax. 501(c)(3) organizations have many benefits which include being exempt from other taxes like federal, state, and other payroll taxes. These organizations are generally non-profits, schools, and churches.
- Those that work with independent contractors. Per the IRS, independent contractors are their own businesses and are responsible for paying their own benefits along with taxes. These contractors aren’t eligible for unemployment insurance, unlike their employee counterparts.
Other types of organizations like agricultural businesses have special rules they must follow regarding this form. For example, these businesses only need to file this form if they paid $20,000 in cash wages or employed 10 or more farm workers for 20 weeks throughout the year.
FUTA tax rates
Luckily, FUTA taxes aren’t as high as FICA tax and the rate is just 6%. Also, FUTA has a much lower wage base than FICA taxes at just $7,000 per employee. So if a business owner paid 5 employees in excess of $7,000 per year it would owe approximately $2,100 in total FUTA tax (7,000*0.06*5).
Also, this tax can be offset by SUTA tax payments. Most states offer tax credits as high as 5.4%, meaning eligible businesses will only pay 0.6% in FUTA tax. This credit is only available to businesses that pay their SUTA taxes promptly, have low employee turnover, and respond to unemployment insurance claims. Practicing these habits will allow business owners to save on taxes, grow their businesses, and strengthen their employee relationships.
Unfortunately, some states borrow money from the federal government, which they use to pay their unemployment benefits. These states are known as credit reduction states as the total credit is prorated. If these states haven’t paid back the loan, they can’t offer employers the full 5.4% credit and can only offer reduced rates. Luckily most states and territories aren’t credit reduction areas, but the Virgin Islands was one in 2018. It’s still labeled as one for 2019, but this can change if it quickly pays it debt off. Also, California was a credit reduction state until it paid its debts in the fall of 2018.
The Virgin Islands has a credit reduction of 3% compared to the standard credit of 5.4%. This means that the 6% FUTA rate would be prorated to 3% in the Virgin Islands, which would be a total FUTA tax of $210 per employee. Any employer that does business in a credit reduction state would have to fill the additional form 940 A along with the standard Form 940. Fortunately, this form is relatively straight-forward as it’s only one page long and prorates the credit per eligible state.
Form 940 step-by-step instructions
This form is relatively simple to complete and this process can be easier with the right payroll software from providers like Gusto. Using the right payroll software can automate completing this form, which saves money and time.
The top area requires some basic information like business EIN, address and name. Part one asks the small business owner how many employees he or she had, business state(s), and credit reduction area.
Part two goes into more detail and has areas that show total payments to employees, exempt payments and total FUTA tax before adjustments. The exempt payments category also mentions common items like group term life insurance, retirement plan contributions, fringe benefits, and dependent care. It has line items that show payments made to employees in excess of $7,000 and prorates this amount by 0.6% to reflect the total FUTA tax.
Keep in mind this form assumes that the small business owner has complied with SUTA rules. For example, they would only be eligible for state credits against FUTA tax if they’ve practiced good habits like minimizing employee turnover, paying SUTA tax on time, and responding to unemployment claims quickly. If they didn’t comply with these best practices, they’d be subject to the entire FUTA rate and it’s best to speak with a tax or financial advisor to determine this.
Parts three and four guide the employer through making adjustments and paying any balance if applicable. As mentioned above, there are adjustments that reduce FUTA tax like state credits, and exempt categories like group term life insurance. These adjustments will lower the FUTA tax before adjustments and the total FUTA tax will be recorded in part four.
This area also shows any payments that are due (if the tax liability is above $500) and any overpayments (i.e refunds). It’s important to note these payments can be made electronically via the EFTPS program.
Part five lets the small business owner record the payments he or she made on a calendar quarter basis and aggregate the total balance. Part six allows the taxpayer to give a third party preparer the ability to discuss this return with the IRS. The last area, part seven, is simple as the taxpayer must sign and date the return here.
Some resources that can assist small business owners with form 940 are:
- Gusto is a premier tax and payroll software. This platform lets users automate payroll for employees, manage employee health insurance plans and of course prepare tax forms. Gusto makes it easy to file form 940 accurately through automation.
- The IRS website is a powerful resource to find tax forms and deadlines. This site changes its pages constantly, so be sure to look for the current year’s requirements. Some important IRS forms related to this guide are Form 940 and Form 940a.
- Small business owners have many tasks to manage, especially managing their employees. They must pay several taxes like FICA, FUTA, and SUTA on behalf of each employee.
- FUTA and SUTA give laid-off workers security in the form of a source of income as they look for jobs.
- Employers must use Form 940 to report FUTA taxes and should check their own states requirements for SUTA.
Disclaimer: This post is for educational purposes only, not tax advice. Consult a tax adviser or CPA for formal advice.