Federal Unemployment Tax FUTA Law and Legal Definition

The Federal Unemployment Tax Act (FUTA), with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. Most employers pay both a federal and a state unemployment tax. Only the employer pays FUTA tax; it is not deducted from the employee's wages.

A state that has not repaid money it borrowed from the federal government is a “credit reduction state.” The Department of Labor determines these states. If an employer pays wages that are subject to the unemployment tax laws of a credit reduction state, the employer must pay additional federal unemployment tax when filing its Form 940. Certain exemptions apply, so a tax professional should be consulted if you have questions about your federal unemployment tax liabilty.