Understanding IRS Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return

1. Introduction – What is Form 940?

IRS Form 940, officially titled “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” is a federal payroll tax document used by employers to calculate and report their annual federal unemployment tax. It is administered by the Internal Revenue Service (IRS) under the authority of the U.S. Department of the Treasury.

Unlike federal income tax, Social Security, or Medicare taxes, federal unemployment tax is paid entirely by the employer. Form 940 reconciles the total wages paid to employees during the calendar year, determines taxable unemployment wages, and calculates the final tax amount owed to the federal government.

2. Purpose of the Form – Why Does Form 940 Exist?

The Federal Unemployment Tax Act (FUTA), together with state unemployment tax systems, provides financial assistance to workers who have lost their jobs. Form 940 exists to ensure that businesses contribute their required share to fund federal unemployment compensation programs.

The standard FUTA tax rate is 6.0% applied to the first $7,000 of taxable wages paid to each employee annually. However, employers who pay state unemployment taxes (SUTA) on time generally receive a maximum tax credit of up to 5.4%, reducing their effective FUTA tax rate to 0.6% ($42 per employee per year).

Form 940 solves the problem of calculating these tax credits, adjusting for multi-state operations or credit reduction states, and ensuring that employers accurately settle their year-end unemployment tax liabilities.

3. Who Needs to File This Form

Most small businesses, corporations, partnerships, and non-profit employers that hire employees must file Form 940 annually. You must file Form 940 if you meet either of these two general testing criteria:

• Wage Threshold Test: You paid total wages of $1,500 or more to employees in any single calendar quarter during the current or preceding calendar year.
• Employee Duration Test: You had one or more employees for at least part of a day in any 20 or more different weeks during the current or preceding calendar year (employees can be full-time, part-time, or seasonal).

Special rules apply for agricultural and household employers. Agricultural employers must file if they paid $20,000 or more to farmworkers in any calendar quarter or employed 10 or more farmworkers during any 20 weeks. Household employers generally report household unemployment taxes on Schedule H (Form 1040) but can elect to file Form 940.

4. Who Is Exempt / Not Required to File

Certain organizations and business structures are not required to file Form 940. You are exempt if any of the following apply:

• Sole Proprietors Without Employees: Self-employed individuals, independent contractors, or single-member LLC owners who do not hire W-2 staff.
• Tax-Exempt 501(c)(3) Organizations: Religious, charitable, and educational non-profit organizations exempt from federal unemployment tax under IRC Section 3306(c)(8).
• Governmental Entities: Federal, state, local, and Indian tribal government organizations.
• Employers Below Wage & Week Thresholds: Businesses that did not reach $1,500 in quarterly wages or employ a worker in 20 different weeks during the year.

5. When to File

Form 940 is an annual tax return covering the calendar year from January 1 through December 31.

The standard deadline to file Form 940 and pay any remaining balance is January 31 following the close of the tax year. However, if you deposited all required FUTA taxes on time throughout the year, you receive an automatic 10-day extension, moving your filing deadline to February 10.

Although Form 940 is filed annually, FUTA tax payments may be required quarterly. If your accumulated FUTA tax liability exceeds $500 in any calendar quarter, you must deposit the tax electronically via the Electronic Federal Tax Payment System (EFTPS) by the last day of the month following the end of that quarter.

6. Where and How to File

Employers can submit Form 940 electronically or by physical paper mail. E-filing is widely recommended by the IRS because it reduces processing errors and provides instant receipt confirmation.

If you choose paper filing, where you send the form depends on your primary business location and whether you are enclosing a check or money order payment. You must mail the form to the specific IRS address as per instructions listed in the official Form 940 filing manual. Do not send Form 940 to standard income tax addresses.

7. Step-by-Step Instructions to Fill the Form

Form 940 is organized into seven parts that break down your wage calculations, tax credit adjustments, and deposit liabilities. The table below summarizes the key parts of the form.

Form Part	Part Name	Instruction / Description
Part 1	State & Return Details	Indicate state abbreviation(s), check if a multi-state employer, and mark credit reduction state boxes if applicable.
Part 2	FUTA Taxable Wages	Calculate total payments to employees, exempt payments, and wages exceeding the $7,000 limit to determine taxable FUTA wages.
Part 3	Credit Adjustments	Calculate adjustments if you paid state unemployment tax late or if you operate in a credit reduction state.
Part 4	Tax Calculation	Determine total FUTA tax owed after adjustments, compare with deposits made, and calculate balance due or overpayment.
Part 5	Quarterly Tax Liabilities	Report your quarterly FUTA tax liabilities if your total annual tax exceeds $500.
Part 6	Third-Party Designee	Authorize a CPA, payroll provider, or tax preparer to discuss the return with the IRS.
Part 7	Signatures	Sign, date, and provide contact details for the authorized corporate officer, partner, or owner.

Detailed Filling Steps

1. Complete Employer Information: Enter your Employer Identification Number (EIN), legal business name, trade name (DBA), and address at the top of the form.
2. State Information (Part 1): Enter the postal abbreviation for the state(s) where you paid unemployment taxes. If you paid wages in multiple states, check the multi-state box and attach Schedule A (Form 940).
3. Calculate Taxable Wages (Part 2): Enter total gross payments made to all employees (Line 3). Subtract exempt payments such as fringe benefits or retirement contributions (Line 4) and payments exceeding $7,000 per employee (Line 5) to arrive at total taxable FUTA wages (Line 7).
4. Calculate FUTA Tax Before Adjustments (Part 2): Multiply total taxable FUTA wages by 0.006 (0.6%) to find your base FUTA tax.
5. Apply Credit Adjustments (Part 3): Complete Line 9 or Line 10 if you paid state unemployment taxes late, were exempt from state unemployment tax, or paid wages in a credit reduction state using Schedule A.
6. Determine Final Tax or Refund (Part 4): Compare your total FUTA tax liability against payments and deposits made during the year. Enter any remaining balance due or overpayment amount.
7. Fill Quarterly Liability Schedule (Part 5): If your total FUTA tax is over $500, break down your tax liability by quarter (Q1, Q2, Q3, Q4). The sum of all four quarters must equal your total tax in Part 4.
8. Sign and Date (Part 7): An authorized business owner, partner, or corporate officer must sign, date, and provide their title.

8. Required Documents/Information Needed Before Filling

Before completing Form 940, gather the following payroll records and accounting files:

• Employer Identification Number (EIN): The nine-digit federal tax ID assigned to your business entity.
• Annual Payroll Summary Reports: Detailed reports showing gross wages paid to each employee during the calendar year.
• State Unemployment Tax (SUTA) Records: Statements showing state unemployment tax account numbers, state taxable wages, and proof of timely SUTA payments.
• Schedule A (Form 940): Required if you operate in multiple states or in a state subject to FUTA credit reduction.
• Quarterly EFTPS Deposit Records: Receipts confirming quarterly FUTA tax deposits made during the year.

9. Common Mistakes to Avoid

Payroll errors on Form 940 can lead to IRS audit notices or unexpected tax bills. Watch out for these common errors:

• Withholding FUTA Tax from Paychecks: Deducting FUTA tax from employee pay. FUTA is an employer-paid tax and must never be withheld from worker wages.
• Forgetting the $7,000 Limit: Failing to cap taxable FUTA wages at the first $7,000 paid to each worker per year.
• Ignoring Credit Reduction States: Forgetting to complete Schedule A if your business operates in a state that has an outstanding federal unemployment loan.
• Mismatched Quarterly Liabilities: Entering quarterly deposit amounts in Part 5 instead of actual quarterly tax liabilities.
• Missing Quarterly Deposits: Accumulating over $500 in FUTA liability during a quarter but waiting until year-end to pay, resulting in late-deposit penalties.

10. Penalties for Non-Filing or Errors

Failing to file Form 940 or paying FUTA taxes late triggers statutory IRS penalties and interest charges:

• Failure-to-File Penalty: Charged at 5% of the unpaid tax amount per month (or fraction of a month) up to a maximum of 25%.
• Failure-to-Pay Penalty: Charged at 0.5% per month on unpaid taxes, increasing up to a maximum of 25%.
• Failure-to-Deposit Penalty: Charged for late quarterly deposits, ranging from 2% (1 to 5 days late) to 15% (if not paid after IRS notice).
• Interest Charges: Statutory interest accrues daily on unpaid tax balances and penalties from the original due date until fully paid.

11. Related Forms or Schedules

Employers managing payroll compliance frequently use these related federal tax forms:

• Schedule A (Form 940): Multi-State Employer and Credit Reduction Information.
• Form 941: Employer’s QUARTERLY Federal Tax Return (used for income tax, Social Security, and Medicare taxes).
• Form 944: Employer’s ANNUAL Federal Tax Return (for small employers with low annual payroll tax liabilities).
• Form 943: Employer’s Annual Federal Tax Return for Agricultural Employees.
• Schedule H (Form 1040): Household Employment Taxes.
• Form W-2: Wage and Tax Statement.

12. Frequently Asked Questions

1. What is the difference between Form 940 and Form 941?

Form 940 is an annual return used strictly to report federal unemployment tax (FUTA). Form 941 is filed quarterly to report employee federal income tax withholding, Social Security tax, and Medicare tax.

2. What is the current FUTA tax rate?

The gross FUTA tax rate is 6.0% on the first $7,000 of wages per employee. Most employers receive a state tax credit of up to 5.4%, making the net FUTA tax rate 0.6% ($42 per worker per year).

3. Do employees pay FUTA tax?

No. FUTA tax is paid entirely by the employer. It must not be deducted or withheld from employee paychecks.

4. What is a credit reduction state?

A credit reduction state is a state that borrowed money from the federal government to pay unemployment benefits and has not repaid it. Employers in these states receive a reduced FUTA tax credit, resulting in a higher effective FUTA tax rate.

5. When do I need to make quarterly FUTA tax deposits?

You must make a quarterly FUTA deposit using EFTPS if your accumulated, unpaid FUTA tax liability exceeds $500 at the end of any calendar quarter.

6. Can I e-file Form 940?

Yes. Form 940 can be e-filed through IRS-approved payroll software or by a certified tax professional, offering faster processing and immediate receipt confirmation.

13. Conclusion – Key Takeaways

IRS Form 940 is a mandatory annual payroll return for employers who meet federal wage or employment week thresholds. It ensures that businesses properly fund the federal unemployment system and accurately account for state unemployment tax credits. By maintaining accurate payroll records, applying the $7,000 per-employee wage limit, accounting for credit reduction states on Schedule A, and making required quarterly deposits via EFTPS, business owners can ensure seamless payroll compliance and avoid costly penalties.