If you're an employer in the United States, understanding Form 940 is essential for staying compliant with federal tax obligations. This form, officially known as the Employer's Annual Federal Unemployment (FUTA) Tax Return, might seem daunting at first, but with the right guidance, you'll find it's a manageable part of your annual tax responsibilities.
Form 940 is the annual tax form that employers use to report their Federal Unemployment Tax Act (FUTA) tax liability. FUTA taxes fund unemployment compensation programs for workers who lose their jobs. Unlike other employment taxes that involve employee withholding, FUTA tax is paid entirely by the employer, employees don't contribute to this tax through payroll deductions.
The current FUTA tax rate is 6.0% on the first $7,000 of wages paid to each employee during the calendar year. However, most employers receive a credit of up to 5.4% for state unemployment taxes paid, which effectively reduces the FUTA tax rate to 0.6% for most businesses.
You must file Form 940 if you meet either of these conditions:
First, you paid wages of $1,500 or more to employees in any calendar quarter during the current or previous year. Second, you had one or more employees for at least some part of a day in any 20 or more different weeks during the current or previous year. The employee doesn't need to be the same person, and the weeks don't have to be consecutive.
There are some exceptions to these rules. Certain types of employers, such as household employers who didn't meet specific thresholds and agricultural employers with different requirements, may have modified filing obligations.
The foundation of Form 940 is calculating your FUTA tax liability accurately. Here's how it works: you multiply the first $7,000 of each employee's annual wages by 6.0%. This $7,000 threshold is called the FUTA wage base. Any wages you pay to an employee beyond $7,000 in a calendar year are not subject to FUTA tax.
For example, if you have an employee who earns $50,000 annually, you only calculate FUTA tax on the first $7,000 of their wages. At 6.0%, this equals $420 before credits. If you're eligible for the maximum state unemployment tax credit of 5.4%, your actual FUTA tax on this employee would be $42 (0.6% of $7,000).
It's important to note that wages subject to FUTA tax include most payments for services, including salaries, commissions, bonuses, vacation allowances, and the value of certain fringe benefits. However, some payments are exempt from FUTA tax, such as certain fringe benefits, group-term life insurance, employer contributions to retirement plans, and workers' compensation.
One of the most significant aspects of Form 940 is the state unemployment tax credit. If you paid state unemployment taxes on time and in full, you can claim a credit against your FUTA tax liability. This credit can be as much as 5.4% of FUTA taxable wages, which dramatically reduces your federal obligation.
To qualify for the full credit, you must have paid all required state unemployment taxes by the due date of Form 940, including any extensions. If you're filing in a credit reduction state, a state that has outstanding federal loans for its unemployment program, your credit will be reduced, and you'll owe additional FUTA tax. The IRS publishes a list of credit reduction states annually, and this information is crucial for accurate filing.
Form 940 is organized into several parts that guide you through the calculation process. Part 1 asks you to identify which type of return you're filing and whether certain situations apply to your business, such as having paid wages in a state that's subject to credit reduction.
Part 2 is where you calculate your FUTA tax. You'll report the total payments made to all employees, identify payments exempt from FUTA tax, and calculate the taxable FUTA wages for each employee. This section requires careful attention to ensure you're not overpaying by including wages above the $7,000 threshold or underpaying by missing taxable compensation.
Part 3 determines your FUTA tax adjustments and credits. Here you'll claim your state unemployment tax credit and make any necessary adjustments. This is also where credit reduction states come into play, as you'll need to calculate additional tax if applicable.
Part 4 calculates your total FUTA tax liability after credits, and Part 5 reports any tax deposits you've already made throughout the year. The difference between your total liability and deposits made determines whether you owe additional tax or have overpaid.
While Form 940 is filed annually, you may need to make quarterly deposits of your FUTA tax throughout the year. If your FUTA tax liability exceeds $500 for the calendar year, you must deposit the tax by the last day of the month following the end of the quarter in which you exceeded that threshold.
For instance, if your cumulative FUTA tax liability reaches $501 in the second quarter (April through June), you must deposit that amount by July 31. If your liability never exceeds $500 for the entire year, you can pay the full amount with your Form 940 instead of making quarterly deposits.
Form 940 must be filed by January 31 of the year following the calendar year for which you're reporting. However, if you deposited all your FUTA tax when due, you have until February 10 to file. This extended deadline gives you additional time to prepare accurate returns.
If you need more time beyond these deadlines, you can request an automatic extension by filing Form 8868, which gives you an additional six months to file. However, an extension to file is not an extension to pay—any tax due must still be deposited by the original deadline to avoid penalties and interest.
Several common errors can complicate your Form 940 filing. One frequent mistake is miscalculating the $7,000 wage base per employee. Remember, this is per employee, per year, not a total amount for all employees. Another error involves incorrectly claiming the state unemployment tax credit, either by claiming it when you haven't actually paid state unemployment taxes or by claiming it for a credit reduction state without calculating the reduction.
Failing to make timely quarterly deposits is another pitfall. Even if you ultimately don't owe much tax, missing deposit deadlines can result in penalties. Keep careful records throughout the year to track when your cumulative liability crosses the $500 threshold.
The IRS requires you to keep all records relating to Form 940 for at least four years. These records should include your employer identification number, amounts and dates of all wage payments, the fair market value of in-kind wages, names and addresses of employees, dates of employment, and records of your FUTA tax deposits.
Good record-keeping throughout the year makes filing Form 940 much easier and protects you in case of an audit. Many businesses use payroll software that automatically tracks this information and can generate reports that simplify the Form 940 preparation process.
Form 940 is a critical compliance requirement for employers, but understanding its instructions makes the process straightforward. By calculating your FUTA taxable wages correctly, claiming appropriate credits, making timely deposits, and filing by the deadline, you'll fulfill this important tax obligation efficiently. When in doubt, consulting with a tax professional or accountant can ensure accuracy and help you avoid costly mistakes. Many businesses also find that partnering with offshore bookkeeping services can provide cost-effective support for managing payroll tax compliance, including Form 940 preparation, while ensuring accuracy and freeing up internal resources for core business activities. Remember that tax laws and forms can change, so always check for the most current version of Form 940 and its instructions on the IRS website.
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