By now, business owners have likely realized that the number of tax documents that the IRS requires companies to file is significant. There’s a reason that accountants responsible for corporate taxes make so much money.
What is Form 940?
Form 940 is the Employer’s Annual Federal Unemployment tax return, which was created after the Federal Unemployment Tax Act (FUTA) was passed. That law provided the necessary guidelines for how individual states should handle their unemployment benefits programs.
The goal of the FUTA Tax is to provide the federal government with the resources needed to give money to individuals who have lost their jobs through acts out of their control. If an employee is fired, they don’t get unemployment. The money is also used as an emergency fund if an individual state needs resources.
The 940 form, like many of the forms that the IRS has companies fill out, is meant to calculate what you’ve already paid to your state and to the federal government in the previous tax year. Because the employer pays this tax and nothing is contributed by the employee, only the employer has paperwork to file.
The rationale is that the employee doesn’t choose to be let go. Rather, the employer lets the employee go. So the government is taxing the employer for the instances when it lets people go.
Keep your small business tax forms straight.
The maximum FUTA tax rate is 6%; however, that’s if your state doesn’t collect a single penny in unemployment insurance. A company can deduct up to 5.4% of its federal unemployment tax if they have paid that to their state instead, which means that the smallest amount that a company will pay to the federal government is 0.6%. The tax is collected on the first $7,000 that you pay to employees throughout the year.
Who Must File IRS Form 940?
The IRS provides two questions to help determine if you must file the 940 tax form before offering a series of exceptions. The two questions are:
Did any employees receive wages of $1,500 or more in any quarter in the previous two years? Since it is 2016, that means 2014 and 2015. Next year, it would mean 2015 and 2016.
Was there one or more employee working for you for at least part of a day each week for 20 different weeks in the year? For example, if you had an employee work one day a week for 25 weeks, your answer would be yes.
Related Article: Employee Definitions for Full-Time and Part-Time Workers
If you answer yes to either of these questions, then you are responsible for paying the tax to the federal government.
When to Pay FUTA & File Form 940
As stated above, filing Form 940 is meant to be done for the previous year’s payments. It acts as a receipt of sorts, which tells the IRS what payments you made. For example, you would submit Form 940 in 2016 for payments you made in 2015.
Like quarterly income taxes, the FUTA must be paid by the last day of the month immediately following the end of a quarter.
January to March: Pay April 30th
April to June: Pay July 31st
July to September: Pay October 31st
October to December: Pay January 31st of the next year
Because the tax is only paid on the first $7,000, the majority of the tax will be paid in the first quarter. If an employee earns $28,000 or more, they’ll have received $7,000 in the first quarter — that’s the amount you’ll pay the tax on.
This becomes problematic for employers if they have more lower paid employees rather than fewer highly paid employees. Since every employee incurs a tax, it becomes more of a burden as more employees join the company.
You must file Form 940 on January 31st of the following year; therefore, making a payment and submitting the form happen at the same time.
What About State Tax?
The federal tax makes up only one part of unemployment taxation. Individual businesses have to pay their state unemployment tax as well, and the rules for each state is different. For example, many states continue charging the tax after the $7,000 federal tax limit; therefore, you may not have to pay much to the federal government, but you’ll have to pay more to the state.
Further, the tax rate varies widely from business to business. In South Carolina, it is 3.3%; whereas, in Arkansas, it is 13.1%. In the case of Arkansas, you’ll be able to claim 5.6% of that 13.1% tax to minimize your federal tax bill.
State tax calculations are dependent on your company's unemployment history. In essence, the more employees that have gone on to collect unemployment from the state in the previous year dictates what your rate will be in the next year. If you have very few former employees actually taking insurance, your business is not a burden on the state and there is less need to tax you.
Because of this, it's important to keep quality paperwork on your employees and pay attention to any unemployment claims with your business name. If you fire an employee, but don’t keep any paperwork about why you fired them, they could claim unemployment insurance which would cost your business down the road. On the other hand, if you have kept quality paperwork and can prove that you let the employee go with cause, you won’t have to pay any insurance on them.
Justworks Can Help
If you’re a Justworks client, you can rest easy knowing that we’ll ensure that the state and federal unemployment insurance rates are paid on time. Justworks will also update you on when the rates change from year to year and ensure paperwork gets to the correct agencies in every state. You have a business to run; Justworks can handle the backend work.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.