Under the provisions of the American Federal Unemployment Tax Act (FUTA), a Federal tax is levied on employers covered by the Unemployment Insurance program at a current rate of 6.0% on wages up to $7,000 a year paid to a worker. The law, however, provides a credit against federal tax liability of up to 5.4% to employers who pay state taxes timely under an approved state UI program. Accordingly, in states meeting the specified requirements, employers pay an effective Federal tax of 0.6%, or a maximum of $42 per covered worker, per year.
The credit against the Federal tax may be reduced if the state has an outstanding advance (commonly called a “loan”). When states lack the funds to pay UI benefits, they may obtain loans from the federal government. To assure that these loans are repaid, and in accordance with Title XII of the Social Security Act, the federal government is entitled to recover those monies by reducing the FUTA credit it gives to employers, which is the equivalent of an overall increase in the FUTA tax. When a state has an outstanding loan balance on January 1 for two consecutive years, and the full amount of the loan is not repaid by November 10 of the second year, the FUTA credit will be reduced until the loan is repaid. This process is commonly called FUTA Credit Reduction and was designed as an involuntary repayment mechanism. The reduction schedule is 0.3% for the first year and an additional 0.3% for each succeeding year until the loan is repaid, and is applied retroactively.
The U.S. Department of Labor (DOL) released its list of potential credit reduction states for 2017 and California and the U.S. Virgin Islands continue to have outstanding FUTA loans. California had recently paid off its FUTA loan, which was more than $3 billion, however in May 2017 borrowed an additional $550,000,000. As of May 30th, the outstanding balance was $52,676,012 and if it is not repaid by November 10th, then a credit reduction of 2.1% will take effect leaving the net FUTA tax rate at 2.7%. The U.S. Virgin Islands has an outstanding FUTA loan balance as of May 30th of $65,863,691, and after their credit reduction of 3.2%, the net FUTA tax rate will be 3.8%.
If you are using a payroll service, the rate is most likely being calculated and remitted at the .6% rate, and for a California employer, that can amount up to $147, per employee, of additional taxes that they will need to remit in January 2018. If you have employees in either of these ‘states’, then consider budgeting for this potential additional tax expense, as the final determination will be made in late November 2017.