As a sole proprietor in the United States with employees, your tax obligations don’t end at income tax and self-employment tax. You also need to understand the Federal Unemployment Tax Act (FUTA) and when Form 940 applies to your business. Failing to comply can result in penalties, missed credits, and unnecessary stress during tax season. This blog will walk you through what FUTA is, who must file Form 940, and how it applies to sole proprietors in 2025.
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💼 What is FUTA?
The Federal Unemployment Tax Act (FUTA) is a U.S. federal law that imposes a payroll tax on employers to fund unemployment benefits for workers who lose their jobs. This tax is paid entirely by the employer and is not deducted from employee wages.
🧾 When Do Sole Proprietors Need to File Form 940?
As a sole proprietor, you must file Form 940 if either of the following applies:
- You paid $1,500 or more in wages to employees in any calendar quarter in the current or previous year.
- You had one or more employees for at least some part of a day in any 20 or more different weeks in the current or previous year (this includes full-time, part-time, and temporary employees).
📋 What is Form 940?
Form 940 is the Employer’s Annual Federal Unemployment (FUTA) Tax Return. It summarizes the FUTA taxes you owe or have paid throughout the year.
Even if you file Form 941 quarterly, you still must file Form 940 annually if you meet the above criteria. The form is due by January 31 each year for the prior tax year.
💰 How Much is FUTA Tax?
For 2025, the FUTA tax rate is typically 6.0% on the first $7,000 of wages you pay each employee. However, you can receive a credit of up to 5.4% for paying state unemployment taxes, reducing your effective rate to 0.6%.
Example: If you pay an employee $8,000 during the year, you only pay FUTA tax on the first $7,000. At the full credit rate, that’s just $42 per employee annually.
🗂️ Filing Requirements & Deadlines
- Form: 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
- Due Date: January 31, 2026 (for 2025 tax year)
- Filing Methods: Paper filing or IRS e-File for Businesses
- Payment: FUTA taxes should be deposited quarterly if your cumulative tax exceeds $500
🔍 Quarterly Deposit Requirements
If your FUTA tax liability exceeds $500 in a quarter, you must deposit the amount by the end of the following month. If the liability is under $500, you can carry it over to the next quarter until it exceeds the $500 threshold.
⚠️ Common Mistakes Sole Proprietors Make
- Assuming FUTA is optional if you have few employees
- Missing the January 31 deadline
- Failing to take the full 5.4% credit for state unemployment tax
- Not depositing quarterly when required
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📎 What About Independent Contractors?
If you only pay independent contractors (non-employees), you are not responsible for FUTA tax on those payments. Instead, you may need to file Form 1099-NEC to report contractor earnings.
📌 Final Thoughts
Form 940 is a crucial part of payroll compliance for sole proprietors with employees. Missing deadlines or miscalculating FUTA tax can lead to penalties, audits, and financial strain. If you’re unsure about your obligations, consider using payroll software or working with a tax professional who specializes in small business taxation.
Staying informed and proactive ensures your business remains compliant and stress-free during tax season.
