As someone who has spent nearly 40 years in the industry, I understand the importance of staying informed about changes with unemployment tax that could increase risk for employers across the country.A hot topic this year is the Federal Unemployment Tax Act (FUTA) credit reductions and additional add-ons.The U.S. Department of Labor (USDOL) has now made it official: California and the U.S. Virgin Islands will both see FUTA credit reductions for the 2025 tax year.
Overview of a FUTA Credit Reduction
Most every employer in the United States pays federal unemployment taxes for employees in their hire.They pay tax on the first $7,000 each person earns, each year.The tax rate at which they pay is 6%. However, if they pay all taxes timely and in full to the state each quarter, they are eligible for a 5.4% reduction in tax.So they would pay only 0.6% rather than the full 6% for each employee.When a state unemployment trust fund balance is in peril of becoming insolvent, the Governor of the state may request an advance from the federal government through a Title XII loan.Since it is a loan, it must be repaid or risk accruing interest and a reduction in the 5.4% credit to which they would otherwise be entitled. If the loan is not repaid within the deadline, rather than a 5.4% credit, they would receive only a 5.1% credit; a 0.3% reduction. For each consecutive year there is an outstanding balance, a further reduction in the credit would be instituted, as well as the potential for other add-ons.
The United States Department of Labor, Employment and Training Administration, Office of Unemployment Insurance will outline states and territories that might experience not only a FUTA credit reduction but also a 2.7% add-on and a Benefit Cost Rate (BCR) add-on. These changes are due to several factors:
- Outstanding Federal Advances:States and territories with outstanding federal advance can trigger a series of additional FUTA credit reductions.
- Incremental FUTA Credit Reductions:For each consecutive January 1 with an outstanding advance, after the second one, employers are subject to an additional 0.3% reduction in FUTA credit. This reduction increases following the third consecutive January 1 with an outstanding advance.
- 2.7% Add-On:After the third consecutive January 1 with an outstanding advance, employers face an additional FUTA credit reduction known as the 2.7% add-on.
- BCR Add-On:States are also potentially subject to the BCR additional credit reduction formula, which applies when five consecutive January 1’s have passed with an outstanding advance.
What USDOL Officially Announced for the 2025 Tax Year
According to the USDOL’s latest release:
- California: 1.2% FUTA credit reduction
- U.S. Virgin Islands: 4.5% FUTA credit reduction
These reductions apply to employers filing Form 940 for 2025 and reflect ongoing unpaid federal loans that each jurisdiction used to support its unemployment insurance trust fund.
Why these reductions continue to rise
Under federal law, when a state or territory doesn’t fully repay its outstanding federal unemployment loan—or the interest owed—by the annual deadline, it faces an additional 0.3% FUTA credit reduction for each consecutive year the balance remains unpaid.
Both California and the Virgin Islands have carried these loans for several years, which is why their FUTA credit reductions continue to increase annually.
The Benefit Cost Rate (BCR) Add-On — And a Bit of Relief
For 2025, both California and the Virgin Islands were also at risk of triggering a Benefit Cost Rate (BCR) Add-On, an additional penalty that could have dramatically increased their FUTA tax rates.
The good news: both jurisdictions requested BCR Add-On waivers, and both were approved. This is particularly significant for California — without the waiver, employers there would have faced the highest tax rate increase in the history of the federal-state unemployment insurance program.
Looking ahead to 2026
While the waiver approval provides short-term relief, California’s challenges aren’t over. With an estimated $21 billion outstanding federal loan balance, the state must make meaningful repayment progress before November 2026 to avoid another FUTA credit reduction — and the potential return of the BCR Add-On next year.
What this means for employers
Employers in California and the Virgin Islands should plan now for higher FUTA liabilities when filing their 2025 Form 940 returns. To stay ahead:
- Review your Q4 payroll tax forecasts to account for the increased FUTA cost.
- Monitor your state’s loan repayment activity throughout 2026.
- Keep watch for USDOL’s fall update, which will confirm any changes for the upcoming year.
Experian’s perspective
At Experian Employer Services, we know how fast-changing unemployment insurance and payroll tax regulations can affect your business. Our team closely tracks federal and state developments — like FUTA credit reductions — to help employers stay informed, compliant, and prepared.
Stay tuned for more updates as we continue to monitor FUTA developments for 2026.