Federal Employment Taxes

Employers generally must withhold federal income tax from employees’ wages.

Federal Insurance Contributions Act (FICA) taxes

FICA taxes are comprised of two separate taxes, social security (OASDI) and Medicare taxes, that are paid on wages earned for services performed.  Employers withhold and pay their employees’ share of the FICA taxes and also pay the employer share.

Federal Unemployment (FUTA) Tax

Employers report and pay FUTA tax separately from Federal Income tax, and Social Security and Medicare taxes. You pay FUTA tax only from employer funds. Employees do not pay this tax or have it withheld from their pay.

The FUTA tax levies a federal tax on employers covered by a state’s UI program. The standard FUTA tax rate is 6.0% on the first $7,000 of wages subject to FUTA. The funds from the FUTA tax create the Federal Unemployment Trust Fund, administered by the United States Department of Labor (DOL).

Generally, employers may receive a credit of 5.4% when they file their IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to result in a net FUTA tax rate of 0.6% (6.0% – 5.4% = 0.6%).

Some states take Federal Unemployment Trust Fund loans from the federal government if they lack the funds to pay UI benefits for residents of their states.

A state is a credit reduction state if it has taken loans from the federal government to meet its state unemployment benefits liabilities and has not repaid the loans within the allowable time frame. A reduction in the usual credit against the full FUTA tax rate means that employers paying wages subject to UI tax in those states will owe a greater amount of tax.

If a state has outstanding loan balances on January 1 for two consecutive years, and does not repay the full amount of its loans by November 10 of the second year, the FUTA credit rate for employers in that state will be reduced until the loan is repaid.

The reduction schedule is 0.3% for the first year the state is a credit reduction state, another 0.3% for the second year, and an additional 0.3% for each year thereafter that the state has not repaid its loan in full.  Additional offset credit reductions may apply to a state beginning with the third and fifth taxable years if a loan balance is still outstanding and certain criteria are not met.

The Department of Labor (DOL) runs the loan program and announces any credit reduction states after the November 10 deadline each year. DOL has information about the credit reduction states and loan balances on the FUTA Credit Reductions page of its Department of Labor website.

How does the credit reduction affect employment taxes?

The result of being an employer in a credit reduction state is a higher tax due on the Form 940.

For example, an employer in a state with a credit reduction of 0.3% would compute its FUTA tax by reducing the 6.0% FUTA tax rate by a FUTA credit of only 5.1% (the standard 5.4% credit minus the 0.3% credit reduction) for an effective FUTA tax rate of 0.9% for the year.

Any increased FUTA tax liability due to a credit reduction is considered incurred in the fourth quarter and is due by January 31 of the following year.

Employers who think they may be in a credit reduction state should plan accordingly for the lower credit. The IRS includes the credit reduction states, the applicable credit reduction rates, and an example in the Schedule A (Form 940), Multi-State Employer and Credit Reduction Information. The Instructions for Form 940 also has information about the credit reduction and deposit rules.

Reporting the credit reduction

Employers calculate the credit reduction using the Schedule A (Form 940). The schedule was revised in 2011 to allow for the growth in the number of credit reduction states and for the calculation of the increased FUTA tax liability.

On Schedule A (Form 940), every state has:

  • A checkbox (to be checked if an employer paid state unemployment taxes to that state)
  • A box for the FUTA taxable wages the employer paid in that state (to be filled in if the state is a credit reduction state and the employer paid wages subject to UI tax in the state).

The following employers use the Schedule A (Form 940):

  • Employers that paid FUTA taxable wages and UI tax in more than one state
  • Employers that paid FUTA taxable wages and UI tax in any credit reduction state, even if the employer is a single-state employer. These employers report the FUTA taxable wages and multiply by the credit reduction rate (0.3%, 0.6%, 0.9%, etc) to calculate the total credit reduction, which the employer carries forward to Form 940.

If an employer paid UI taxes to more than one state, it must check all of those states on Schedule A (Form 940), whether the states are credit reduction states or not. Additionally, for states that are credit reduction states, employers must enter the FUTA taxable wages the employer paid in that state, even if the employer paid wages in only one state. However, FUTA taxable wages that are excluded from UI are not subject to credit reduction. For more information, see the Instructions for Schedule A (Form 940).

Refer to Publication 15, Employer’s Tax Guide and Publication 15-A, Employer’s Supplemental Tax Guide on Payroll Masters forms page for more information on FUTA tax.

Additional Medicare Tax

Beginning January 1, 2013, employers are responsible for withholding Additional Medicare Tax on an employee’s wages, railroad retirement (RRTA) compensation, and self-employment income over certain thresholds.

You are required to begin withholding Additional Medicare Tax in the pay period in which you pay wages and compensation in excess of the threshold amount to an employee. There is no employer match for the Additional Medicare Tax.

An employer that does not meet its withholding, deposit, reporting, and payment responsibilities for Additional Medicare Tax may be subject to all applicable penalties.

Self-Employment Tax (SE tax)

Self-Employment Tax (SE tax) is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most employees.

California Employment Taxes

Employers conducting business in California are required to register with, file reports and pay taxes to EDD

Unemployment Insurance (UI)

The UI program was established as part of a national program administered by the U.S. Department of Labor under the Social Security Act. The UI program provides temporary payments to individuals who are unemployed through no fault of their own. The UI program is funded through payroll taxes paid by the employer.

Government entities and certain nonprofit employers may elect the reimbursable method of financing UI in which they reimburse the UI Fund on a dollar-for-dollar basis for all benefits paid to their former employees.

Employment Training Tax (ETT)

ETT is an employer-paid tax. ETT provides funds to train employees in targeted industries to improve the competitiveness of California businesses. The ETT fund promotes a healthy labor market by helping California businesses invest in a skilled and productive workforce and develop the skills of new and incumbent workers.

State Disability Insurance (SDI)

The SDI program is funded through a payroll deduction from employees’ wages. SDI tax allows the Disability Fund to pay Disability Insurance (DI) and Paid Family Leave (PFL) benefits to eligible claimants. DI benefits are paid to eligible workers experiencing a loss of wages when they are unable to perform their regular or customary work due to a non-work-related illness or injury, pregnancy, or childbirth. PFL benefits are paid to eligible workers who take time off of work to care for a seriously ill child, parent, parent-inlaw, grandparent, grandchild, sibling, spouse, or registered domestic partner, or to bond with a new child.

California Personal Income Tax (PIT)

California Personal Income Tax (PIT) is a tax levied on the income of California residents and on income that California nonresidents derive within California. California PIT withholding is based on the amount of wages paid, the number of withholding allowances (Form W-4 or DE 4) claimed by the employee, and the payroll period.

For additional information on PIT withholding refer to California’s Employer’s Guide.

The California PIT withholding schedules are available on online at www.edd.ca.gov/payroll_taxes/rates_and_withholding.htm#withholding