What is the FUTA Credit?
Under the provisions of the Federal Unemployment Tax Act (FUTA), a Federal tax is levied on employers covered by the Unemployment Insuranceprogram at a current rate of 6.2% on wages up to $7,000 a year paid to a worker. The law, however, provides a credit against Federal tax liability of up to 5.4% to employers who pay state taxes timely under an approved state UI program. Accordingly, in states meeting the specified requirements, employers pay an effective Federal tax of 0.8%, or a maximum of $56 per covered worker, per year.
The credit against the Federal tax may be reduced if the state has an outstanding advance (commonly called a “loan”). When states lack the funds to pay UI benefits, they may obtain loans from the Federal government. To assure that these loans are repaid, and in accordance with Title XII of the Social Security Act, the federal government is entitled to recover those moneys by reducing the FUTA credit it gives to employers, which is the equivalent of an overall increase in the FUTA tax. When a state has an outstanding loan balance on January 1 for two consecutive years, and the full amount of the loan is not repaid by November 10 of the second year, the FUTA credit will be reduced until the loan is repaid. This process is commonly called FUTA Credit Reduction and was designed as an involuntary repayment mechanism. The reduction schedule is 0.3% for the first year and an additional 0.3% for each succeeding year until the loan is repaid. From the third year onward, there may be additioal reduction(s) in the FUTA tax credit (commonly dubbed “add-ons”).
Last year three states, Indiana, Michigan, and South Carolina endured the FUTA credit reduction. This year, as many as 25 states may face the FUTA credit reduction. For first year defaults, the FUTA rate increases to 1.1% of the first $7000 in wages. Subsequent years increase .3% per year in default.