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IRS Form 940: Reporting Federal Unemployment (FUTA) Tax
Form 940 is the annual return for federal unemployment tax. Learn how FUTA works, the credit mechanism with state unemployment taxes.
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Form 940 is the annual return for federal unemployment tax. Learn how FUTA works, the credit mechanism with state unemployment taxes.
This guide is designed for first-pass understanding. Start with core terms, then apply the framework in your own account workflow.
Form 940 is the annual return for reporting Federal Unemployment Tax Act (FUTA) taxes. While most employees never think about it, every employer in America is paying federal unemployment tax on their behalf. The FUTA system funds state unemployment agencies and provides a safety net for workers who lose their jobs through no fault of their own. The form itself is straightforward, but the underlying system; with its frozen wage base and credit mechanisms; is one of the most outdated corners of the tax code.
The Federal Unemployment Tax Act was enacted in 1939 as part of the Social Security Act amendments, building on the original unemployment insurance framework established in 1935 during the Great Depression. The idea was straightforward: create a federal-state partnership where employers pay taxes to fund unemployment benefits for workers who are laid off.
The system works through a credit mechanism. The federal FUTA tax rate is 6.0% on the first $7,000 of each employee's wages. However, employers who pay state unemployment taxes (SUTA) on time receive a credit of up to 5.4%, reducing the effective federal rate to just 0.6%. This credit mechanism encourages states to maintain their own unemployment insurance programs; if a state program fails to meet federal standards, the credit can be reduced.
The $7,000 wage base has been frozen since 1983, making it perhaps the most outdated threshold in the entire tax code. When set, $7,000 represented a meaningful portion of annual wages. Today, it's a fraction of the average worker's earnings. By contrast, state unemployment tax wage bases vary widely; from $7,000 in states that match the federal minimum to over $60,000 in Washington state.
An employer must file Form 940 if they meet either of two tests:
Special rules apply to agricultural employers (who must pay $20,000 or more in wages or employ 10 or more workers in 20 weeks) and household employers (who must pay $1,000 or more in a quarter).
The filing deadline is January 31 of the year following the tax year. However, if all FUTA tax was deposited on time throughout the year, the deadline extends to February 10. FUTA tax deposits are generally required quarterly if the accumulated tax exceeds $500.
The maximum FUTA tax per employee at the effective 0.6% rate is just ($7,000 x 0.6%). For an employer with 50 employees, that's $2,100 annually; a modest cost that funds the federal share of the unemployment system.
The federal FUTA tax rate is 6.0% on the first $7,000 of each employee's annual wages. However, employers who pay state unemployment taxes on time receive a credit of up to 5.4%, reducing the effective federal rate to just 0.6%. For most employers, the maximum FUTA tax per employee is $42 per year ($7,000 x 0.6%).
No. FUTA is paid entirely by the employer — it is never deducted from employee wages. This distinguishes it from Social Security and Medicare taxes (FICA), which are split between employer and employee. Employees may see SUTA (state unemployment tax) on their pay stubs in a few states, but FUTA is exclusively an employer obligation.
Form 940 is due January 31 of the following year. If you deposited all FUTA tax when due, you have until February 10 to file. FUTA deposits are due quarterly if your cumulative FUTA liability exceeds $500. Most small employers deposit once a year because the low per-employee cost keeps the annual total under $500.
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Missing the credit reduction adjustment is a significant error. When a state borrows from the federal government to pay unemployment benefits and doesn't repay the loan within two years, employers in that state face a FUTA credit reduction. This means the 5.4% credit is reduced, and employers must pay more than the usual 0.6% effective rate. After the COVID-19 pandemic, several states carried outstanding federal loans, and employers in those states needed to account for the credit reduction on their Form 940.
Incorrectly calculating the $7,000 wage base per employee is another common issue. The $7,000 limit applies per employee, per calendar year. If an employee leaves and is rehired, the wages from both periods count toward the $7,000 cap. If an employee transfers between related companies, special rules may apply.
Late deposits trigger penalty and interest charges. FUTA tax must be deposited by the last day of the month following the quarter if the accumulated tax exceeds $500. Employers who only file annually sometimes forget to make quarterly deposits.
Misclassifying workers as independent contractors affects FUTA as well as other employment taxes. If the IRS determines that workers classified as contractors are actually employees, the employer can be liable for back FUTA taxes, penalties, and interest.
The COVID-19 pandemic tested the unemployment system like never before. Unemployment claims surged to historic levels in 2020, and many states exhausted their unemployment trust funds. The federal government provided emergency supplements through programs like Pandemic Unemployment Assistance (PUA) and Federal Pandemic Unemployment Compensation (FPUC), which were funded separately from FUTA.
As states borrowed from the federal government to cover benefits, several became credit reduction states. This meant employers in those states paid higher effective FUTA rates — an additional cost passed to businesses at a time when many were already struggling. The number of credit reduction states has fluctuated as states repay their loans.
There have been periodic proposals to raise the FUTA wage base from $7,000 to a higher amount, reflecting four decades of wage growth. Proponents argue that the low wage base forces high tax rates on low-wage employment while exempting most of the payroll of higher-paid workers. However, business groups oppose increases, citing the additional cost burden.
The IRS continues to require electronic payment of FUTA taxes through the Electronic Federal Tax Payment System (EFTPS) for most employers. All businesses are required to deposit federal taxes electronically.
For more information, see the official IRS page: About Form 940.
This article is educational and does not constitute tax advice. Consult a qualified tax professional for guidance specific to your situation.