In this video, I explain Federal Unemployment Tax Act as covered on the CPA exam.
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The Federal Unemployment Tax Act (FUTA) is a law that sets up a system for unemployment insurance, which is managed by individual states. This system is designed to offer financial support to workers who have lost their jobs. Here's a breakdown of how it works:
Federal Guidelines, State Administration: While FUTA sets the basic rules at the federal level, each state is responsible for running its own unemployment insurance program. This means states can set their own standards and decide how much money people will receive.
Eligibility for Employers: Not all employers are required to participate in this system. To be part of it, an employer needs to meet one of two conditions:
Have a payroll of at least $1,500 in any quarter of the year.
Employ at least one person for a total of 20 weeks within a year.
This includes all types of employers, whether they are businesses, non-profits, or other entities.
Exclusion of Self-Employed Persons: Unlike the Federal Insurance Contributions Act (FICA), which covers self-employed individuals, FUTA does not require self-employed persons to participate. This means that if you are self-employed, you are not automatically covered under this unemployment insurance system.
In summary, FUTA establishes a federally-guided but state-run program to support workers who are unemployed. Employers are required to participate if they meet certain payroll or employment duration criteria, but self-employed individuals are not included in this program.
The funding for unemployment insurance under the Federal Unemployment Tax Act (FUTA) primarily comes from payroll taxes that are paid by employers, not employees. Here's a more detailed explanation:
Federal Unemployment Tax Rate: Employers are required to pay a federal unemployment tax, which is currently set at 6.0% of the first $7,000 of each employee's annual compensation. This means that for each employee, the maximum federal tax an employer could pay per year is $420 (6% of $7,000).
Credit for State Unemployment Tax Payments: Employers can receive a credit against their federal unemployment tax for the state unemployment taxes they pay. This credit can be as much as 5.4% of the first $7,000 of compensation paid to each employee. Essentially, if an employer pays the full state unemployment tax, they might only need to pay 0.6% (6.0% - 5.4%) for the federal unemployment tax.
Reduced State Tax Rates for Low Unemployment Claims: States can offer reduced unemployment tax rates to employers who have a lower-than-average history of unemployment claims from former employees. This means an employer with a good record of maintaining employment can pay less in state unemployment taxes, potentially increasing their credit against the federal tax.
In summary, the unemployment insurance system is funded by taxes paid by employers, based on a percentage of their payroll. The federal tax rate is 6.0% on the first $7,000 of each employee's wages, but employers can get a significant credit for paying state unemployment taxes. Additionally, employers with fewer unemployment claims may benefit from reduced state tax rates.
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