A Tax Cut for Your Business? Don’t Spend It Yet

On July 1, 2011, the federal unemployment tax (FUTA) rate is scheduled to drop. This is the date on which a 0.2% surtax is set to expire. But don’t spend your tax savings yet. Things could change soon.

FUTA tax
FUTA tax, which covers half of extended unemployment benefits paid by the states as well as providing funds for states to borrow to cover their unemployment benefit obligations, applies to the first $7,000 of each employee’s wages. The FUTA rate is 6.2%. After June 30, 2011, the FUTA tax rate is scheduled to decrease to 6.0%.

This rate, however, is not necessarily the rate that you pay. You are entitled to a credit for state unemployment taxes. If you are entitled to the maximum credit of 5.4%, the FUTA tax rate after credit becomes 0.8% (0.6% after June 30, 2011).

The maximum credit applies if:

  • You paid your state unemployment taxes in full, on time, and on all the same wages as are subject to FUTA tax, and
  • Your state is not determined to be a credit reduction state (it has not repaid the federal government the borrowed funds it borrowed). For 2010, Indiana, Michigan, and South Carolina were credit reduction states. Instructions to Form 940 detailed the extent of the credit to which employers in these states were entitled. It is too early to know which states will be credit reduction states in 2011.

History of the surtax
The FUTA surtax was originally enacted in 1976 to fund the extension of unemployment benefits. The loans used to fund the extended benefits were retired in 1987, but the surtax continued. The surtax has been extended seven times, most recently by the Worker, Homeownership, and Business Assistance Act of 2009.

When the FUTA tax took effect in 1939, the wage base was set at $3,000; it was raised to $4,200 in 1972, $6,000 in 1978, and the current $7,000 in 1983.

Looking ahead
The Administration wants to make the surtax permanent and raise the wage base on which the FUTA tax is figured. Under budget proposals for fiscal year 2012, the wage base subject to FUTA would be increased from $7,000 to $15,000 (starting in 2014), and adjusted annually for inflation (starting in 2015).

The U.S. Chamber of Commerce wants the surtax to disappear and opposes any increase in the wage base.

Here's my take on the tax proposals: FUTA tax, which may seem modest compared with other taxes, is yet another payroll burden. This serves as a disincentive for hiring at a time when more jobs is what the economy so desperately needs. Hiking the wage base and again extending the surtax is a measure that works against job creation.

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