Along with New York and the U.S. Virgin Islands, California is facing a reduction in Federal Unemployment Tax Act (FUTA) credit for 2024, which means employers in California pay higher FUTA taxes retroactively on wages paid in 2024 due to the state’s outstanding federal loans. The FUTA Tax Credit Reductions effectively increase the tax liabilities by 0.9% on the first $7,000 of wages for each employee in 2024 both in California and New York. For each employee in the U.S. Virgin Islands in 2024, FUTA Tax Credit Reductions will increase tax liability by 4.2% on the first $7,000 of wages. The additional amounts are due in January 2025 with the 2024 fourth-quarter federal unemployment tax payment. See chart below.
What Is the Federal Unemployment Tax Act (FUTA)?
The Federal Unemployment Tax Act (FUTA), passed in 1939, established a federal payroll tax to help fund and insure state unemployment benefits across the United States. This base federal payroll tax is 6% on the first $7,000 each employee makes in a year, which the employer is responsible for paying. Employers in most states are provided a Credit of 5.4% towards this 6% FUTA rate. This results in a rate of 0.6% for employers.
State governments are also responsible for collecting unemployment taxes from employers and providing state unemployment funds for workers who need to collect unemployment insurance due to losing their jobs. However, sometimes, the states do not have the funds needed to pay unemployment compensation to everybody who needs to claim it. In this case, states must borrow from the federal fund.
During the COVID-19 pandemic, many states needed to borrow from the federal government to ensure that unemployed workers could continue to access the unemployment benefits they needed to provide for themselves and their families. This left some states with outstanding federal loans, leading to a credit reduction and an adjusted higher net FUTA tax rate for employers. The adjusted higher net rate is calculated retroactively for the previous year, and employers are expected to pay in January of the following year.
Understanding California’s 2024 FUTA Credit Reduction
According to the U.S. Department of Labor, California was one of several states that did not pay back its federal unemployment loans by the November 10th deadline. California, New York, and the Virgin Islands are subject to a federal unemployment insurance (FUTA) credit reduction in 2024 because they did not repay their FUTA loan balance. This repayment failure resulted in the state losing a portion of its FUTA credit. As a result, California is experiencing an additional 0.3% in their FUTA credit reduction rate, which means employers in 2024 will have to pay a higher FUTA rate of 0.9% total retroactively for 2024. The Credit Reduction increases each year the outstanding loan balance is not paid. A credit reduction results in an increase in the net tax rate.
According to IRS regulations, any increased FUTA tax liability due to a credit reduction is considered incurred in the fourth quarter of the relevant calendar year and is due by January 31st of the following year. California employers will retroactively pay the additional amount of FUTA taxable wages for 2025 when filing the 2024 Form 940.
How the FUTA Tax Rate is Calculated
Beginning on January 1st of every calendar year, FUTA is calculated on every eligible employee’s first $7,000 in wages. The default credit for states is 5.4%, which, when subtracted from the base tax rate of 6%, yields a default net rate of 0.6%.
However, as a result of California’s 2024 FUTA credit reduction, the state’s default credit is being reduced by an additional 0.3% (for a total of 0.9%) to 4.5%, resulting in an adjusted net FUTA tax rate for 2024 of 1.5%—an increase of 0.9% (6.0 – 4.5% equals 1.5%). A retroactive credit reduction of 0.9% increases the net tax rate to 1.5%.
What California’s 2024 FUTA Credit Reduction Means for Employers
California employers are expected to pay the adjusted net FUTA tax rate for 2024 retroactively for the year by January 31, 2025
This means that in January, employers filing Form 940 for 2024 will be required to pay a total of 1.5% tax on the first $7,000 of wages per eligible employee, instead of California’s original 0.6% FUTA tax rate for 2024.
For example:
An employer with 50 employees in California in 2024 normally owes $42 per employee—a 0.6% FUTA tax due on each employee’s first $7,000 of the calendar year—which comes to $2,100 in total for the business. However, California’s FUTA credit reduction increases the tax to 1.5%, or $105 per employee, or $5,250 in total for the business.
To help employers understand the impact of a FUTA credit reduction, the IRS has produced a webpage explaining how FUTA works and how to report the credit reduction properly on Form 940.
As an employer, it is important for you to stay informed about changes to FUTA tax rates, state unemployment taxes, and the overall financial health of your state’s unemployment trust fund. If you have any questions about the specific implications of California’s FUTA credit reduction for your business or need help developing strategies to navigate the potential challenges of an increased state unemployment tax, we encourage you to consult with tax professionals or legal advisors.
According to the United States Department of Labor, as of the end of the 3rd quarter in 2024, the state of California has an outstanding Title XII loan balance of over $20 billion. It is unlikely this federal loan balance will be paid in 2025. Employers should also budget and prepare for an additional credit reduction next year.
This information is provided as a courtesy and should not be taken as legal or tax guidance for business owners or payroll professionals. If you have any further questions about California’s FUTA credit reduction, we encourage you to seek advice from a qualified CPA, tax attorney, or tax advisor.
