In October, the Department of the Treasury announced jurisdictions facing a federal credit reduction for their federal unemployment insurance programs. These jurisdictions are California, Connecticut, Illinois, New York, and the Virgin Islands.
This article will clarify what this credit reduction means and how it will affect employers in these jurisdictions.
What is a FUTA tax?
Under the Federal Unemployment Tax Act (FUTA), states are given help in paying for unemployment benefits for employees who are terminated for any reason except gross misconduct. This tax applies to any employer who pays wages of $1,500 or more.
FUTA is not paid by the employees, but it is annually paid by the employer on the first $7,000 of wages to each employee. The tax rate is 6%. Employers may receive a credit for state unemployment tax of 5.4%, bringing the tax rate down to 0.6%.
What does a FUTA credit reduction mean?
If a state cannot meet its unemployment liabilities in a calendar year, it can take out federal loans to cover the unemployment benefits it is liable for. These loans need to be repaid in an agreed-upon window of time.
If they are not repaid, the Department of Treasury issues a state’s usual credit reduction against the full 6% FUTA tax rate. This means that qualified employers will owe a greater amount of tax.
Any state with an outstanding balance on these loans for two consecutive years will face credit reductions if their balance is not paid off by November 10 of the second year.
This reduction is 0.3% for each year that the state has not repaid its loan in full.
What does this mean for employers?
Being in a credit reduction state means that employers will not be able to receive the full 5.4% state credit toward their FUTA tax. In all, this will mean a higher tax bill for employers until the loan is repaid to the federal government in full.
COVID-19 put a strain on an unprecedented amount of state unemployment insurance trust funds. In 2020-2021, 21 states and the Virgin Islands had to request loans from the federal government to cover their liabilities. In this calendar year, California, Connecticut, Illinois, New York, and the Virgin Islands still owe on the balance of these loans and are subject to FUTA tax reductions.
If you are an employer in these jurisdictions, that means you will be carrying a part of the burden by paying a greater amount of taxes this year and in increasing increments each year that that balance isn’t paid off.
Need more information on FUTA and other taxes that affect you as an employer? Check out Complete Payroll’s blog. With hundreds of articles on everything you ever wanted to know about HR and payroll, Complete Payroll can help keep you informed.