Employers are required to file Form 940 each year to report and pay the federal unemployment tax. This annual federal unemployment tax return helps fund unemployment benefits for workers who lose jobs. While the filing process is straightforward, mistakes can occur, and correcting Form 940 quickly is essential to avoid penalties and added tax liability.
Unlike other federal employment taxes, Form 940 has no separate correction form. If an error is discovered, employers file an amended return by completing a new Form 940 for the correct tax year and checking the amended return box. This process applies whether the error involves wages paid, exemptions, or credit reduction state adjustments.
Understanding how to identify, document, and correct errors is vital for small business owners, agricultural employers, household employers, and any company with one or more employees. This guide explains the correction process in detail, including filing procedures, tax payments, and resolution options available through the Internal Revenue Service. By following the steps outlined here, employers can pay FUTA tax accurately, stay compliant with the federal government, and avoid unnecessary costs.
Understanding Form 940 and FUTA Taxes
Form 940, the Employer’s Annual Federal Unemployment Tax Return, is used to report and pay FUTA tax. Employers pay this federal unemployment tax to the federal government to help fund unemployment benefits for workers who lose their jobs. The form is required from most businesses that pay wages to one or more employees, including small businesses, agricultural employers, and household employers.
Unlike income tax or FICA taxes, which are shared between employers and employees, the employer pays FUTA tax entirely. The standard FUTA tax rate applies only to the first $7,000 of wages paid to each employee during the calendar year. Employers may also receive credits for state unemployment taxes they pay, although a credit reduction applies in states that borrowed from the federal government to cover unemployment benefits.
Key points about filing Form 940 include:
- The Internal Revenue Service requires employers to file Form 940 annually, even if no FUTA tax is due, provided they paid wages that meet the filing threshold.
- Agricultural employers must file if they paid cash wages of $20,000 or more to agricultural employees in any calendar quarter or employed ten or more workers for at least part of a day in twenty or more weeks during the tax year.
- Household employees and domestic services in a private home may also be subject to a filing requirement if employers pay cash wages of $1,000 or more in any calendar quarter.
- Employers file electronically or by mail using the address listed in the Form 940 instructions, depending on whether a tax payment is included.
- Employer identification numbers must be used consistently across all federal employment taxes, including Form 940, Form 941, and related filings.
Form 940 differs from other federal employment tax forms because there is no separate correction form. When making corrections, employers must use a new Form 940 for the relevant tax year and mark it as an amended return. This process applies whether the business is a sole proprietor, a successor employer, or a company that has stopped paying wages during the year.
Common Errors on Form 940 That Require Corrections
Mistakes on Form 940 are common and can lead to additional tax liability or IRS notices. Recognizing these errors helps employers correct them quickly and avoid penalties.
Frequent mistakes include:
- Computational errors: Employers sometimes miscalculate FUTA tax liability by applying the wrong FUTA tax rate or failing to account for the correct state unemployment taxes paid. These errors often lead to an incorrect balance of tax due.
- Reporting errors: Businesses may report the wrong totals for wages paid, cash wages, or payments exempt from FUTA. Misstating the number of employees during the tax year is another frequent reporting issue.
- Classification errors: Some employers mistakenly classify workers as independent contractors when they should be treated as employees. When this occurs, the FUTA tax was not properly reported and must be corrected.
- Exemption errors: Certain fringe benefits, such as group term life insurance, are exempt from FUTA tax. If these benefits are incorrectly included as taxable wages, the result is an overpayment of unemployment taxes.
- State credit errors: Employers who operate in a credit reduction state must reduce the credit claimed for state unemployment taxes. Failing to apply the credit reduction properly results in FUTA tax being underreported.
These errors can increase the tax liability, delay refunds, or cause the Internal Revenue Service to send penalty notices. Employers should review their records carefully to ensure all filings are accurate.
Step-by-Step Guide to Correcting Form 940
Correcting Form 940 requires following specific IRS procedures. Filing an amended return properly ensures the corrections are accepted and applied to the correct tax year.
Phase 1: Identify and document errors
- Review payroll records, state unemployment tax filings, and records of employer payments through a financial institution. This ensures all reported wages and credits are accurate.
- Determine whether the error involves wages paid, exemptions, employee classification, or state credits. Identifying the error type helps target the correction.
- Calculate how the mistake affects tax liability. Determine whether the tax was paid late and whether interest or penalties are likely to apply.
Phase 2: Obtain the correct forms
- Employers should download the correct version of Form 940 for the tax year being corrected from the IRS website. Using the wrong year’s form can delay processing.
- Prior years require the exact form and instructions for that year to ensure calculations match IRS requirements.
- Always confirm that the instructions and the form are updated to the latest revision for the tax year.
Phase 3: Complete the amended return
- Please check the box labeled "amended return" in the top right corner of Form 940. If you do not check this box, the IRS may treat the filing as a duplicate rather than a correction.
- Enter the correct employer identification number, business name, and trade name line. Use the same EIN that was reported on the original filing.
- Update the relevant sections of the form:
- Part 1: Correct state information, including whether wages were reported in a credit reduction state.
- Part 2: Recalculate FUTA tax liability, adjusting for wages paid, payments exempt, and taxable wage bases.
- Part 3: Adjust late state unemployment tax payments or exclusions from state coverage.
- Part 4: Recalculate the corrected FUTA tax liability, compare it with employer payments already made, and determine if a balance or refund is due.
Phase 4: File and pay
- Employers are encouraged to file electronically for faster processing and confirmation. Electronic filing reduces the risk of common processing errors.
- If filing by mail, the return must be sent to the address listed in the instructions on Form 940. The correct address depends on whether a payment is included.
- Additional tax payments can be made through the Electronic Federal Tax Payment System (EFTPS), by credit or debit card, by payment through a financial institution, or by check or money order payable to the United States Treasury.
IRS Penalties and Interest for Incorrect Form 940
When Form 940 is filed late, underpaid, or corrected after the due date, the IRS may assess penalties and interest. These charges increase the total payments employers owe and can grow quickly if not resolved.
Failure-to-file penalties
- The penalty is 5% of the unpaid tax for each month or part of a month that the return is late.
- The maximum failure-to-file penalty is 25% of the unpaid balance.
- A minimum penalty applies if the return is more than 60 days late, even if no tax was due.
Failure-to-deposit penalties
The IRS imposes penalties when FUTA tax deposits are not made on time. The penalty rate depends on how late the deposit is, as shown below:
1. 1–5 Days Late
- Penalty Rate: 2% of the unpaid deposit
- Explanation: Applies when an employer makes a deposit just a few days past the due date.
2. 6–15 Days Late
- Penalty Rate: 5% of the unpaid deposit
- Explanation: Charged when the deposit is more than a week overdue but under 15 days.
3. 16 or More Days Late
- Penalty Rate: 10% of the unpaid deposit
- Explanation: Imposed when deposits are not made for more than two weeks.
4. After IRS Demand Notice
- Penalty Rate: 15% of the unpaid deposit
- Explanation: The highest penalty, applied if the IRS issues a demand for immediate payment and the balance remains unsettled.
Interest charges
- Interest accrues daily from the original due date until the IRS fully receives the tax paid.
- The interest rate is based on federal short-term rates plus 3% and is updated every calendar quarter.
- Interest applies to the unpaid tax and any penalties added to the balance.
Correcting Form 940 after errors are discovered reduces penalties and prevents additional interest from accumulating. Acting quickly is the most effective way for employers to avoid unnecessary costs.
Trust Fund Recovery Penalty (TFRP) and Form 940
The Internal Revenue Service uses the Trust Fund Recovery Penalty as a powerful enforcement tool. While FUTA tax is not usually considered a trust fund tax, the penalty can apply when a business fails to meet its overall employment tax obligations.
Why FUTA is different
- FUTA tax is paid entirely by the employer rather than withheld from employee wages, which differs from income tax and FICA taxes. Because of this, FUTA is not typically classified as a trust fund tax.
- The IRS may still include FUTA obligations when a business has failed to pay FUTA tax and other federal employment taxes.
When TFRP may apply
- The penalty may apply when a business has unpaid FUTA tax and unpaid trust fund taxes, such as withheld income tax or employee FICA taxes. In these cases, the IRS often considers all outstanding employment taxes together.
- Employers who leave multiple tax debts unresolved over prior years may face personal liability under the TFRP.
Who qualifies as a responsible person?
- A responsible person is anyone with authority over the business’s finances, such as corporate officers, business owners, or partners.
- Employees who handle payroll or bookkeepers with check-signing authority may also be held responsible if they manage tax payments.
- Third-party payroll providers may be considered responsible if they fail to make timely employer contributions on behalf of a client.
How the IRS defines willfulness
- The IRS defines willfulness as knowing about unpaid tax obligations and deliberately choosing to pay other creditors first.
- Actions such as paying suppliers, issuing owner distributions, or continuing operations while leaving federal employment taxes unpaid may all be considered willful behavior.
Resolution Options if You Owe Additional FUTA Tax
Correcting Form 940 may result in additional tax liability. If this occurs, the IRS offers several resolution programs to help employers manage payments and reduce penalties.
Payment plans and installment agreements
- Employers who owe less than $25,000 in federal employment taxes may apply online for a payment plan with monthly installments. This option provides flexibility for small businesses.
- Streamlined installment agreements are available for balances between $10,000 and $25,000. These agreements involve shorter repayment terms and require less financial disclosure.
- Traditional installment agreements are used when liabilities are higher. These require Form 433-B, a Collection Information Statement for Businesses, and may involve selling or liquidating assets before approval.
Penalty abatement
- First Time Abate relief can remove penalties if the employer has been compliant for the previous three years and has filed all required returns for the current tax year.
- Reasonable cause abatement may apply when natural disasters, serious illness, or reliance on incorrect professional advice prevents timely filing or payment.
- Employers must provide documentation, such as medical records or financial statements, to show they acted in good faith and made reasonable efforts to comply.
Offer in Compromise
- An Offer in Compromise allows employers to settle their FUTA tax debt for less than the full amount if paying in full would cause financial hardship.
- The IRS reviews financial disclosures to determine whether the proposed settlement reflects the employer’s ability to pay.
- Employers must submit Form 656, the required financial forms, and an application fee unless they qualify for a low-income waiver.
Currently Not Collectible status
- Businesses may request the Currently Not Collectible status if paying the FUTA tax debt would cause severe financial hardship.
- Employers must submit Form 433-B along with proof of monthly income and expenses.
- While the CNC status temporarily suspends IRS collection efforts, penalties and interest continue to accrue until the tax is paid or the collection statute expires.
Real-World Examples of Form 940 Corrections
Practical examples illustrate how errors on Form 940 occur and how employers resolve them. These case studies show the importance of timely corrections and accurate reporting.
- Multi-state employer credit error: A manufacturing company in several states mistakenly claimed full unemployment tax credits in a state with a credit reduction. The IRS issued a notice assessing additional FUTA tax and interest. The employer filed an amended Form 940 with Schedule A to account for the credit reduction and paid the balance due.
- Worker classification correction: A consulting firm reclassified several contractors as employees after an IRS determination. The correction required amending Form 940 for FUTA tax and filing Forms 941-X for FICA taxes. The firm requested penalty abatement because it had relied on professional advice, and the IRS granted the request.
- Overpayment refund claim: A service company overstated the payments exempt from FUTA and overpaid unemployment taxes. The company filed an amended return to show the corrected total payments and claimed a refund. After verifying the claim, the IRS issued the refund with interest.
- Successor employer issue: A corporation that acquired another business failed to account for wages already paid by the predecessor employer. This omission caused the underreporting of FUTA tax liability. The corporation filed an amended Form 940 as a successor employer, corrected the tax calculation, and entered a monthly installment agreement to pay the balance due.
Frequently Asked Questions
How do I correct an error on Form 940?
Correcting Form 940 requires filing an amended return using the correct IRS form for the tax year. Employers should check the amended return box, update any lines related to wages paid, exempt payments, or state unemployment taxes, and file electronically or by mail. The Internal Revenue Service requires the same employer identification number and business name used on the original filing to avoid delays.
What role do state unemployment taxes play in FUTA calculations?
Employers pay federal and state unemployment taxes, which work together to fund unemployment benefits. Most businesses receive a credit for employer contributions to state programs, which reduces their FUTA tax liability. If the company operates in a credit reduction state, the credit is reduced, and the tax paid to the federal government increases. Employers must file Schedule A with Form 940 when this applies.
Who must file Form 940 each tax year?
Form 940, the employer’s annual federal unemployment tax return, must be filed if an employer paid $1,500 or more in wages during any calendar quarter or had one or more employees for at least part of a day in 20 weeks during the tax year. This applies to small business owners, agricultural employers, sole proprietors, and even households that pay cash wages to domestic employees.
What types of payments are exempt from FUTA tax?
Certain fringe benefits and payments exempt from FUTA tax include group term life insurance, some employer contributions to retirement plans, and specific payments for agricultural labor or domestic services in a private home. Employers must carefully review exemptions because misreporting them can create errors in total payments or tax liability. A tax preparer can help review exemptions and ensure the filing form is accurate.
How can employers pay FUTA tax after filing Form 940?
Employers can make tax payments through the Electronic Federal Tax Payment System, a financial institution, or by credit or debit card. Payments may also be made by check or money order if filing a paper tax return. The Internal Revenue Service requires that all tax paid be matched with the employer identification number and tax year to ensure the correct account is credited at the federal level.
What happens if a business stops paying wages but still owes FUTA tax?
If a sole proprietor or small business has stopped paying wages, the employer must still file Form 940 for the year wages were last paid. The tax return must reflect total payments and tax liability through the final calendar quarter. Employers may request an amended return if errors are discovered, and they must still pay the FUTA tax owed to the federal government.
