Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return

Understanding Form 940: The Employer’s Guide to FUTA Tax

The world of taxes can be confusing, especially for business owners. One form that often causes head-scratching is Form 940. Let’s break down what this form is all about and why it’s important for you as an employer.

What is FUTA Tax and Why Does it Exist?

Before we dive into Form 940, it’s essential to understand what FUTA tax is. FUTA stands for the Federal Unemployment Tax Act. It’s a federal tax that, along with state unemployment taxes, funds unemployment benefits for eligible workers who lose their jobs. Think of it as an insurance system for the workforce, ensuring there’s a safety net for those who experience job loss through no fault of their own.

FUTA is paid by employers, not employees. This is different from other payroll taxes, like Social Security and Medicare, where both the employer and employee contribute. The FUTA tax is just for employers.

How Form 940 Works: A Step-by-Step Look

Form 940 is the vehicle employers use to calculate and report their FUTA tax liability for a given calendar year. Here’s a simplified overview of how it works:

1. Calculating the Taxable Wage Base: FUTA tax applies to the first $7,000 paid to each employee during the calendar year. So, once an employee’s wages exceed $7,000, the employer doesn’t pay FUTA tax on any wages they earn above that amount. This wage base is set by law and can change periodically.
2. Determining the FUTA Tax Rate: The gross FUTA tax rate is typically 6.0%. However, most employers can qualify for a credit of up to 5.4% if they also pay state unemployment taxes on time and meet other requirements. This means that the effective FUTA tax rate is usually 0.6% (6.0% – 5.4%). The credit can vary based on state compliance.
3. Calculating the FUTA Tax Liability: To calculate your FUTA tax liability, you multiply the taxable wage base by the net FUTA tax rate (usually 0.6%).
4. Reporting on Form 940: You will use Form 940 to total up all of your taxable wages, calculate the total FUTA tax due, and report the amount you have deposited (or will need to pay) to the IRS.
5. Payment of FUTA Tax: If your annual FUTA tax liability exceeds $500, you must make quarterly deposits of the tax. If the liability is less than $500 you may pay the tax when you file Form 940.
6. Filing Form 940: Form 940 must be filed annually. The deadline is usually January 31st of the following year. If you have made all of your FUTA tax deposits timely, you may file Form 940 by February 10th.

Who Needs to File Form 940?

Not every business needs to file Form 940. Generally, you’re required to file Form 940 if either of the following conditions apply:

• You paid wages of $1,500 or more in any calendar quarter of the current year.
• You employed one or more individuals for at least some portion of a day in each of 20 or more different weeks during the current calendar year.

It’s important to note that these are general guidelines. There are specific rules for household employers, agricultural employers, and certain non-profit organizations. It’s always best to consult the IRS guidelines or a tax professional if you’re unsure.

Key Parts of Form 940

Form 940 can seem daunting, but it’s broken down into clear sections. Here’s a quick overview:

• Part 1: Identification and Business Information: This section collects basic details about your business, such as your employer identification number (EIN), name, and address.
• Part 2: Computation of Taxable Wages: Here, you’ll enter the total wages paid to all employees, then identify and exclude payments that aren’t subject to FUTA tax. The remaining amount becomes your taxable wage base.
• Part 3: Computation of FUTA Tax: This part walks you through calculating your FUTA tax liability based on your taxable wages and the applicable tax rate. It accounts for credits for payments to state unemployment funds.
• Part 4: FUTA Tax Liability: Here you will calculate and record your FUTA tax liability for each quarter.
• Part 5: Total FUTA Tax Liability: Here you will record the total FUTA tax due and how much you have deposited with the IRS.
• Part 6: Tax Due or Overpayment: This section allows you to determine if you owe additional taxes or if you have a refund coming from the IRS.

Tips and Strategies for Filing Form 940

• Keep Accurate Records: Maintain meticulous records of employee wages throughout the year. This will make completing Form 940 much easier.
• Stay Current with State Requirements: Ensure that your business is in compliance with state unemployment tax laws. This could affect your federal FUTA tax credit.
• Use Payroll Software: Many payroll software platforms can automatically track wages and calculate FUTA taxes, streamlining the whole process and reducing the chance of errors.
• Consult a Tax Professional: If you’re confused or your business has unique circumstances, get help from a tax expert. They can provide customized advice and ensure you’re meeting your obligations.

Common Mistakes to Avoid with Form 940

• Incorrect Wage Base: Using an incorrect wage base for FUTA calculations will lead to tax errors. Remember the $7,000 per employee limit.
• Forgetting about the State Credit: Not claiming the state unemployment tax credit can result in overpaying your FUTA tax.
• Missed Deadlines: Penalties will be imposed for late filings or late tax deposits. Stay on top of the key filing and deposit dates.
• Incorrect Payments: You must make payments using the electronic funds transfer (EFT) system. Using a method other than EFT will result in penalties.
• Not Reconciling Quarterly Returns: You must make sure that you have paid the correct amount each quarter and reconcile your quarterly tax liability to your annual tax liability.

Related Tax Concepts

Understanding Form 940 involves familiarity with related terms:

• Federal Unemployment Tax Act (FUTA): The federal law that establishes the unemployment tax system.
• State Unemployment Tax Act (SUTA): State-level laws governing unemployment taxes.
• Employer Identification Number (EIN): A unique tax ID number assigned to businesses by the IRS.
• Taxable Wage Base: The portion of an employee’s earnings subject to a specific tax.
• Payroll Taxes: Taxes related to employee wages, including FICA taxes, FUTA, and SUTA.

Conclusion

Form 940 and FUTA tax are integral parts of the employer’s tax responsibilities. By understanding the basics, keeping good records, and seeking help when needed, you can ensure compliance and avoid costly mistakes. Just remember that FUTA is your contribution to the workforce’s safety net, and accurate filing of Form 940 ensures the system works properly.