State and Local Payroll Taxes and Unemployment Insurance

Overview: Why Payroll Taxes Go Beyond Federal

Every paycheck involves more than just federal income tax and FICA. As a bookkeeper or payroll specialist, you must also track unemployment insurance taxes at both the federal and state levels, plus state income tax withholding where applicable. Errors on these obligations can trigger penalties, audits, and back-tax assessments — so precision and careful reference to current official sources are essential.

Federal Unemployment Tax: FUTA

The Federal Unemployment Tax Act (FUTA) requires employers — not employees — to pay a tax that funds the federal portion of the unemployment insurance system. Key facts about FUTA:

• Who pays: The employer alone. Nothing is withheld from the employee's paycheck.
• Wage base: FUTA applies only to the first $7,000 of each employee's wages in a calendar year. Wages above that threshold are exempt from FUTA.
• Gross rate: The statutory FUTA rate is 6.0% of covered wages.
• Credit for state contributions: Employers who pay their state unemployment taxes (SUTA) on time and in full are generally entitled to a credit of up to 5.4% against the gross FUTA rate, reducing the effective FUTA rate to 0.6%.
• Credit reduction states: If a state has borrowed from the federal unemployment trust fund and not repaid it, the IRS reduces the 5.4% credit for employers in that state. The affected states are listed each year in the Form 940 instructions. Always check the current year's instructions.

Practical formula (standard credit applies):

> FUTA tax = Covered wages × 0.6%

FUTA liability is reported annually on IRS Form 940 (Employer's Annual Federal Unemployment Tax Return). Deposits, however, may be required quarterly if cumulative FUTA liability exceeds $500 during the year.

State Unemployment Tax: SUTA

The State Unemployment Tax Act (SUTA) — sometimes called State Unemployment Insurance (SUI) — is the state-level counterpart to FUTA. Each state administers its own program, so rates and wage bases vary by state and by employer.

• Employer-paid: Like FUTA, SUTA is paid solely by the employer in most states (Alaska, New Jersey, and Pennsylvania are notable exceptions where employees also contribute).
• Experience rating: States assign each employer an unemployment tax rate based on the employer's claims history. New employers typically receive a standard new-employer rate until they build a claims record. A business with few layoffs earns a lower rate over time; a business with many claims pays a higher rate.
• Wage base: Every state sets its own taxable wage base, which is often higher than the federal $7,000. Check your state's workforce or labor agency for the current figure.
• Timely payment matters: Paying SUTA on time is what qualifies you for the full 5.4% FUTA credit. Late SUTA payments can cost the employer the credit — effectively raising the FUTA rate.

State Income Tax Withholding

Most states with an income tax require employers to withhold state income tax (SIT) from employees' wages, similar to federal income tax withholding. The bookkeeper's job is to:

1. Collect each employee's state withholding certificate (the state equivalent of the W-4).

2. Determine the employee's filing status and allowances or credits claimed.

3. Use the state withholding tables or formulas published by the state tax agency to find the correct withholding amount for each pay period.

4. Record the amount in the payroll register and remit it to the state on the required schedule.

State withholding tables are organized much like the federal tables in IRS Publication 15-T: you locate the employee's gross wages for the pay period in the left column, then move across to the column matching the employee's filing status and number of allowances. The table amount is the required withholding. Some states use a percentage-of-income formula instead of a table; always follow the current official instructions for your state.

Note: Nine states currently have no broad-based personal income tax. Bookkeepers working in those states skip state income tax withholding but still handle SUTA.

Form 940: Your Annual FUTA Return

IRS Form 940 reconciles the employer's FUTA liability for the entire calendar year. When completing Form 940:

• Report total payments to all employees on the appropriate line.
• Subtract exempt payments (e.g., wages over the $7,000 wage base, certain fringe benefits) to arrive at FUTA taxable wages.
• Apply the FUTA rate and subtract the SUTA credit.
• If operating in a credit-reduction state, complete the Schedule A that accompanies Form 940.
• Compare computed tax to deposits already made and determine any balance due or overpayment.

Always use the current year's Form 940 and its instructions because lines, rates, and credit-reduction state lists can change annually.

Accuracy and Compliance: The Safety Mindset

In payroll work, accuracy is the safety standard. Specific practices to protect your employer and yourself:

• Verify rates annually. FUTA/SUTA rates and wage bases can change. Never rely on memory from a prior year.
• Keep documentation. Retain state withholding certificates, payroll registers, and deposit confirmations for the period required by your state and federal law.
• Reconcile before filing. Cross-check Form 940 totals against your payroll register. A mismatch signals a data-entry error, not a coincidence.
• Meet deposit deadlines. Late deposits attract penalties. Calendar your deposit due dates at the start of each quarter.
• Protect employee data. Payroll records contain Social Security numbers and wage data. Store files securely and limit access — data security is a professional and legal obligation.