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As a business owner, you're required to pay three different types of payroll taxes.
1. FICA (Federal Insurance Contributions Act) is the tax used to fund Social Security and Medicare programs.
2. FUTA (Federal Unemployment Tax Act). Employers pay this federal tax to provide unemployment benefits to laid-off workers.
3. SUTA (State Unemployment Tax Act). State governments also collect taxes known as SUTA that finance each state's unemployment insurance fund.
While FICA may be easy to understand, unemployment tax calculations are easily misunderstood.
How FUTA and SUTA taxes are calculated
The FUTA calculation. The federal unemployment tax rate is 6% on the first $7,000 of each employee's income, regardless of where the company does business. In addition, employers who pay their state's SUTA taxes on time can receive a maximum credit of 5.4%, reducing the FUTA rate to 0.6%. Certain employee benefits-employer contributions to health plans, pensions, and group life insurance premiums, for example-are also excluded from the calculation.
SUTA taxes are more complicated. Tax rates and taxable thresholds (known as wage bases) vary from state to state, industry to industry, and business to business. In Oregon, for example, the first $43,800 of an employee's salary is taxed under SUTA. In Arkansas, that threshold is $10,000. In Oregon, a new employer is taxed at a rate of 2.6%, but more established businesses in that state have rates ranging from 1.2% to 5.4%. Other factors affecting SUTA tax liability include the firm's history of on-time payments to the state insurance fund and the number of former employees receiving unemployment benefits.
How to reduce your SUTA and FUTA tax bills
• Hire cautiously. If you employ someone who doesn't work out, you could end up with additional unemployment claims and a higher SUTA tax rate.
• Train vigorously. To increase productivity and reduce turnover, target your investment in continuing education. Keep employees happy and loyal. Again, high turnover leads to unemployment claims, which leads to bigger SUTA tax bills.
• Terminate judiciously. If you must reduce personnel, consider offering severance or outplacement benefits to terminated employees. The sooner they return to the job market, the fewer the unemployment claims that will be factored into your company's SUTA tax calculation.
• Dispute carefully. Take the time to verify the accuracy of unemployment claims, as bogus representations by former workers can drive up your SUTA taxes. If an employee was fired for gross misconduct and thus disqualifying himself or herself from collecting unemployment, have strong documentation to support the termination.
• Pay regularly. Under federal guidelines, employers who make their SUTA contributions on time can reduce the amount of FUTA taxes by up to 90%.