IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, is a required annual filing for most U.S. employers. It reports federal unemployment tax liability, reconciles state unemployment credits, and ensures compliance with federal unemployment insurance rules. Although the form appears simple, FUTA rules—especially credit reductions and multi‑state wage reporting—can create costly errors if not handled correctly. This guide explains who must file, how FUTA tax works, how to complete the form, and the most common mistakes employers should avoid.
What Is IRS Form 940?
Form 940 is used to report and pay FUTA tax, which funds the federal unemployment trust that supports state unemployment programs. Unlike Social Security and Medicare taxes, FUTA is paid entirely by employers—employees do not contribute.
FUTA works alongside state unemployment insurance (SUI). Employers who pay their state unemployment taxes on time typically receive a 5.4% credit, significantly reducing their federal unemployment tax liability.
Who Must File Form 940?
Most employers must file Form 940 if they meet either of the following IRS tests:
- Paid $1,500 or more in wages in any calendar quarter, or
- Had at least one employee working part of a day in 20 or more different weeks during the year.
These rules apply to full‑time, part‑time, temporary, and seasonal employees. Household and agricultural employers follow separate thresholds under IRS rules.
Even if an employer owes no FUTA tax after credits, Form 940 must still be filed if the business meets the filing requirements.
FUTA Tax Rate and Wage Base
FUTA tax is calculated using three core components:
- Standard FUTA tax rate: 6.0%
- Wage base: First $7,000 of each employee’s annual wages
- Maximum state credit: 5.4%
Employers who qualify for the full credit pay an effective FUTA rate of 0.6%, or $42 per employee per year.
The $7,000 wage base applies to most forms of compensation, including salaries, hourly wages, bonuses, and commissions. Certain payments—such as employer retirement contributions, dependent care assistance, and group‑term life insurance—are excluded from FUTA wages.
Credit Reduction States
Some states borrow from the federal government to maintain unemployment benefits. If a state does not repay its loan on time, it becomes a credit reduction state, which reduces the FUTA credit available to employers.
Employers in these states must:
- Calculate additional FUTA tax, and
- File Schedule A (Form 940) to report the extra liability.
Failing to include Schedule A is one of the most common errors that triggers IRS notices.
How to Complete IRS Form 940
Form 940 is organized into several sections:
1. Employer Information
Enter your EIN, business name, address, and trade name.
2. FUTA Wage Reporting
Report total payments to employees, then subtract exempt payments such as:
- Employer‑funded benefit plans
- Retirement contributions
- Dependent care assistance
- Group‑term life insurance
The result is your FUTA‑taxable wage amount.
3. State Unemployment Tax Information
Indicate whether you paid SUI in one state or multiple states. Multi‑state employers must attach Schedule A.
4. FUTA Tax Calculation
Apply the 6.0% FUTA rate to the first $7,000 of wages per employee, then apply the allowable state credit.
5. Balance Due or Overpayment
Determine whether you owe additional FUTA tax or qualify for a refund.
6. Third‑Party Designee and Signature
Authorize a representative if needed and sign the return.
Common Mistakes to Avoid
1. Missing Schedule A
Employers with workers in multiple states or credit‑reduction states must attach Schedule A. Missing it almost always results in an IRS notice.
2. Incorrect Wage Base Calculations
Employers often miscalculate the $7,000 wage base or fail to exclude exempt payments.
3. Late or Incomplete State Unemployment Payments
Late SUI payments reduce the available FUTA credit, increasing federal tax liability.
4. Misclassifying Workers
Independent contractors are not subject to FUTA. Misclassification can lead to penalties.
Why Form 940 Matters
Accurate Form 940 filing ensures:
- Compliance with federal unemployment tax laws
- Proper reconciliation of federal and state unemployment taxes
- Avoidance of penalties and IRS notices
- Clean year‑end payroll reporting
For employers operating in multiple states or in credit‑reduction states, Form 940 is especially important for preventing unexpected tax liabilities.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.