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When a state is experiencing a large amount of strain on their unemployment fund, they can request loans from the Federal Unemployment Trust Fund to help while handling an increase in claims. The IRS then allows 2 full years for the state to repay these funds in full.
Ex: States who asked for loans in 2020 have until November 10, 2022 to repay the entire loan amount.
If a state fails to repay the loan in time, they are deemed a Credit Reduction State.
Contrary to popular belief, the default rate for Federal Unemployment Tax (FUTA) is not 0.6%. The actual FUTA base rate is 6%. However, the IRS allows employers to receive a credit of up to 5.4% if their FUTA liability is paid timely. As Justworks handles this on your behalf, we lower your effective rate on individual invoices to 0.6%.
Employers in a credit reduction state no longer receive the full benefit of this reduced rate and Justworks must collect additional taxes on any FUTA liable wages retroactive to January 1 of the designated FUTA Credit Reduction year. For each delinquent year, Justworks must withhold an additional 0.3% in FUTA taxes on employees in a designated state until the loan is repaid in full.
CREDIT REDUCTION SCHEDULE
Year 1: Additional 0.3% (Effective rate 0.9%)
Year 2: Additional 0.6% (Effective rate 1.2%)
Year 3: Additional 0.9% (Effective rate 1.5%) etc.
*Note*
It can seem confusing that while called “FUTA Credit Reduction”, the FUTA tax liability is actually increasing.
This is because they are reducing the allowed credit for FUTA.
Currently Affected States and Rates
The US DOL keeps a record of Potential Credit Reduction States and expected additional rate that is periodically updated.
0.9% FUTA Credit Reduction (2024)*
California
New York
On January 1, 2024, the FUTA Credit Reduction rate will increase to 0.9% for these remaining states.
*The following states successfully repaid their loan in 2022: Colorado, Massachusetts, Minnesota, New Jersey and Pennsylvania.
**The following states successfully repaid their loan in 2023: Connecticut and Illinois
How Will You See This On Justworks?
On your payroll invoices, there will be a separate line item for [State] FUTA Credit Reduction broken out by state under Employer Tax Liability.
This additional liability will not necessarily apply to all employees. It is only applicable to employees with a work site state that is noted as FUTA Credit Reduction and only to the same wage base as FUTA ($7,000 in taxable wages in a calendar year).
There are some specific exceptions to FUTA Credit Reduction liability:
- If your business is exempt from FUTA taxes as a 501(c)3, you are not liable
- If an individual employee is exempt from FUTA taxes, no credit reduction will apply to that individual
Why is Justworks collecting now?
While the IRS does not give the official designation of credit reduction state until November 10, the increased FUTA liability is retroactive back to January 1 of that year.
Justworks collects the potential liability in real time to prevent your company from having a large debit at the end of the year.
If a state is able to repay their loan before November 10, Justworks will refund any additional funds withheld directly to your company.
Disclaimer
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.