What is a FUTA Credit Reduction?

Back in 2008-2009, there was a run on unemployment insurance claims due to layoffs as the economy took a downturn. As a result, many state unemployment agencies borrowed money from the federal unemployment agency to cover the claims they were receiving. As a way to collect on the loaned funds, the federal government reduces the FUTA credit given to employers in those states.

To give you a little more background, the Federal Unemployment Tax rate is officially 6.0%. Because each state has its own State Unemployment Insurance systems that tax employers, there is a FUTA credit of up to 5.4% given to employers. This means that the effective tax rate most employers pay is .6% on the first $7,000 each employee is paid.

Employers in the states that still have unpaid balances on their loans will experience a reduction in their FUTA credit.* Rather than a 5.4% credit, they will receive a smaller credit and pay a higher effective tax rate.

Because the states have all year to pay back their loans, the federal government does not make determinations regarding which states are affected until the middle of the 4th quarter. Once the determinations have been made, the payroll system is updated so that a catch-up tax amount is drafted with the last payroll run of the calendar year.