Employer Unemployment Taxes Explained: FUTA and SUTA for Small Businesses

Unemployment taxes are one of those payroll items that quietly sit behind the scenes until a former employee files for benefits—and then they matter a lot. If you run a small business or are handling payroll for an employer, understanding FUTA and SUTA—how they’re calculated, who pays, when to deposit and report, and how state rules change the math—will keep you compliant and help avoid surprise bills or penalties.

What are FUTA and SUTA?

FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act, often called UI tax) are payroll taxes paid by employers to fund unemployment insurance programs. Workers who lose their jobs through no fault of their own may be eligible for benefits funded by these taxes. Unlike Social Security or Medicare, unemployment taxes are typically employer-only: employees don’t have withholding for FUTA/SUTA on their paychecks.

Why two systems?

The federal FUTA tax provides a baseline fund and administrative support for state unemployment programs. States run their own UI systems—setting benefit amounts, eligibility rules, employer tax rates, and taxable wage bases—so SUTA varies widely across the country. FUTA and SUTA work together: employers pay FUTA to the federal government and SUTA to their state agency.

Who has to pay unemployment taxes?

Most employers that pay wages are subject to FUTA and SUTA, but thresholds and definitions matter. Generally, you must pay if you pay cash wages of $1,500 or more in any calendar quarter in a year or if you had at least one employee for part of a day in 20 different weeks in a year. State rules may use different thresholds or look-back periods, so register with your state agency when you hire your first employee.

Independent contractors vs employees

Unemployment taxes apply only to wages paid to employees. Independent contractors (1099 workers) are usually not covered. Misclassification can be costly: if a worker the state considers an employee was treated as a contractor, the employer can be liable for past SUTA, FUTA, penalties, and interest.

How FUTA works (the federal baseline)

FUTA applies to the first $7,000 of each employee’s wages per year (this is the FUTA taxable wage base). The statutory FUTA tax rate is 6.0% on that base, but most employers receive a credit of up to 5.4% if they pay state unemployment taxes on time, yielding an effective federal rate of 0.6% (6.0% – 5.4% = 0.6%).

Key FUTA rules and deadlines

Employers report FUTA annually on Form 940. Deposits are required if your FUTA liability exceeds $500 in a quarter: you must deposit quarterly and can use the Electronic Federal Tax Payment System (EFTPS). Form 940 is due by January 31 for the prior year if you’ve made all deposits; filing late or underpaying can trigger penalties and interest.

FUTA example

If you pay an employee $10,000 in a year, only the first $7,000 is FUTA-taxable. At the net FUTA rate of 0.6% (assuming full state credit), your FUTA liability for that employee is $42 (0.006 x $7,000). If you’re not eligible for the full credit—because of delinquent SUTA—you may owe more.

How SUTA works (state unemployment tax)

State unemployment taxes are where most of the variation lives. Each state sets its own taxable wage base and employer tax rates. The taxable wage base can be as low as a few thousand dollars or higher than $30,000 in some states. Most states use an experience-rating system: employers with frequent layoffs or many claims pay higher rates, while stable employers pay lower rates.

Experience rating and new employers

Experience rating ties your SUTA rate to the amount of benefits charged to your account. If your business has a history of layoffs that resulted in unemployment claims, your rate will rise. New employers typically start at a standard “new employer” rate until they accumulate enough experience to receive their own rate.

Reimbursing employers vs contribution employers

Some public employers or certain nonprofit organizations may opt to be reimbursing employers: instead of paying SUTA on a wage base, they reimburse the state dollar-for-dollar for any benefits paid to former employees. This choice has cash-flow and accounting implications and varies by state.

Interaction between FUTA and SUTA

FUTA’s credit mechanism encourages states to collect SUTA and manage UI funds responsibly. If a state is delinquent in repaying federal loans used for unemployment benefits, employers in that state may have reduced FUTA credits, raising their net FUTA rate. That’s why some employers in certain states see FUTA rates higher than 0.6%.

What reduces FUTA credit

Late SUTA payments, state loan status, and certain state laws can reduce the FUTA credit. Payroll administrators should watch state notices and the IRS’s list of credit reduction states to know when their FUTA liability will increase.

Practical payroll considerations

Setting up unemployment taxes in payroll software requires three things: correct employee classification, the right state account numbers, and correct taxable wage bases and rates. Mistakes—like leaving an employee as exempt from SUTA, using the wrong wage base, or misapplying credits—lead to underpayments and penalties.

Registering with your state

When you hire your first employee, contact your state unemployment agency to register and learn the taxable wage base, deposit schedule, and reporting requirements. States may also require quarterly payroll reports listing wages and new hires.

Deposits and reporting

SUTA deposits are made to the state and follow state-specific thresholds and schedules—some are quarterly, some monthly. FUTA deposits, as noted, depend on quarterly liability. Keep deposits separate and reconcile them with payroll reports to spot errors early.

Common mistakes and how to avoid them

Common pitfalls include misclassifying workers as contractors, failing to register with a state, ignoring state taxable wage bases, missing deposit thresholds, and not tracking experience rate changes. Use payroll software or a trusted payroll provider, document worker relationships carefully, and schedule regular audits of payroll taxes.

Recordkeeping and audits

Keep payroll records, tax returns, deposit confirmations, and benefit charge statements for several years—states and the IRS can audit employers to verify SUTA and FUTA liabilities. Accurate, accessible records make audits faster and reduce potential liabilities.

How unemployment taxes affect hiring and budgets

Unemployment taxes are legitimate business expenses. Because SUTA rates can rise with layoffs, employers sometimes factor potential UI costs into hiring decisions, compensation packages, and restructuring plans. Managing layoffs thoughtfully, offering retraining, or timing separations can influence your experience rating and long-term SUTA costs.

Cost-control strategies

While you can’t avoid paying unemployment taxes if you have employees, you can manage costs: improve retention to lower claims, contest improper benefit claims promptly, and work with state agencies to resolve chargeability disputes. For nonprofits or government entities, explore whether reimbursing status or contributions best suits your finances.

Understanding FUTA and SUTA is less about memorizing every state rate and more about knowing where to look, which numbers matter, and how your payroll practices influence your tax bill. Keep employee classification clear, register early with state agencies, configure payroll for the correct wage bases, reconcile deposits and reports quarterly, and respond quickly to benefit charge notices. That discipline reduces surprises, protects your cash flow, and keeps your business on the right side of both state and federal rules.