This article was updated November 10th to reflect that Colorado paid off its loan by the necessary deadline.
Each year, employers are required to file a Federal Form 940 by January 31 to report their Federal Unemployment Tax Act (FUTA) wages, and pay the applicable tax for the prior year. Employers must pay tax at 6.0% for each employee, up to the federal $7,000 taxable wage base threshold. If all state unemployment tax filings are filed within the deadlines and taxes paid timely and in full, employers are eligible for a credit of 5.4%, thereby lowering the federal tax to just 0.6%. However, this amount can be changed with a FUTA credit reduction.
FUTA Credit Reduction
A consideration employers must have for the filing of the 2022 Form 940 is the possibility of a FUTA credit reduction. A FUTA credit reduction occurs when states obtain an advance from the federal government via a Title XII loan but do not repay within the prescribed period. As a subsection of the Social Security Act, sec 1201, states may request an advance from the Federal Unemployment Account to replenish their unemployment trust fund balances. If the advance is not repaid by September 30th, interest will accrue.
Furthermore, if a state has an advance on January 1st of two or more consecutive years and it is not repaid by November 10th of the second year, a FUTA credit reduction will be imposed. The first-year credit reduction is 0.3% of federal taxable wages. Subsequent years of indebtedness will result in an additional 0.3% for each year until the debt is fully repaid.
States with Outstanding Advances
To provide an example of the impact to employers, for each employee, an employer would have to pay an additional $21 in federal tax until the debt is fully repaid. This could be a substantial increase in taxes for many employers across the country. As of this writing there are at least six states and one territory with outstanding advances. The states of California, Connecticut, Illinois, New York and the Virgin Islands territory all have outstanding advances but do not have a plan to have the amounts paid by the November 10, 2022, deadline. Therefore, these states would have credit reductions on the upcoming Federal Form 940.
The pandemic decimated most states’ unemployment trust fund balances, but many were able to use CARES Act and AARPA funding to replenish them. However other states were not so fortunate and had to request a loan. You may recall this same scenario played out during the Great Recession a number of years back. It took several years for the states with loans to repay them with California being the last state to fully repay its loan. It is anticipated we will find ourselves in a similar situation over the next several years.
Employers should be aware of the possibility of this additional tax cost and include it in their forecasting for upcoming years. We will keep our clients abreast of any changes to this as we are made aware. If you have questions regarding this or any tax related issue, please reach out at email@example.com, or visit Experian Employer Services.