For 2025, many employers — especially those operating in certain states — will see a higher federal unemployment tax burden due to the annual U.S. Department of Labor decision to reduce the FUTA credit for states that haven’t repaid federal unemployment loans.
Why the Credit Reduction Happens
Under the Federal Unemployment Tax Act, employers pay a 6.0% FUTA tax on the first $7,000 of each employee’s wages. Normally, employers receive a credit of up to 5.4% when they also pay state unemployment (SUTA) taxes on time — leading to a net FUTA rate of
0.6%.
However, when a state draws a loan from the federal Unemployment Trust Fund (and does not repay it), that state becomes a “credit reduction state.” If a state has an outstanding loan balance on January 1 for two consecutive years and fails to repay by the November
10 deadline of the second year, employers in that state lose part (or all) of the usual 5.4% credit.
The reduction starts at 0.3% for the first year of non-repayment and grows by 0.3% each additional year until the loan is paid off. Additional penalties — known as “add-ons” — may apply in the third and fifth years the loan remains unpaid, though those add-ons
can be waived under certain conditions.
2025 Impact: States Affected and What It Means for Employers
For the 2025 tax year, only two jurisdictions remain subject to a FUTA credit reduction: California and the U.S. Virgin Islands.
- California — 1.2% credit reduction. The net FUTA tax rate rises to 1.8% (instead of the usual 0.6%), which means employers pay up to $126 per employee on the first $7,000 of wages.
- U.S. Virgin Islands — 4.5% credit reduction. Employers there face a net FUTA rate of 5.1%.
These increased rates are effective for 2025 and will show up when employers file their 2025 annual FUTA returns on Form 940 (and accompanying Schedule A, if required).
What This Means for Employers — Especially in California
- Higher payroll costs. Employers in affected states need to budget for roughly $84–$126 more per employee annually (on the first $7,000 in wages) than they would under the standard FUTA rate.
- Planning and forecasting. Businesses should build the higher FUTA liability into their 2025 year-end payroll budgets — particularly important for firms with large headcounts or those experiencing growth.
- Watch for state repayment or further penalties. The extra cost remains until the state repays its federal UI loan. If the loan remains unpaid long-term, additional reductions or add-ons could occur.
- Compliance and reporting. Employers must correctly report FUTA-taxable wages and any credit reductions on Form 940 (and Schedule A) to avoid underpayment issues.
Broader Context: What Happened Since 2020
Many states borrowed Title XII federal advances during the pandemic as unemployment surged and state UI trust funds were strained and depleted. Those loans started to come due — and states failing to repay in a timely manner triggered automatic FUTA credit
reductions starting in 2022.
Over the past few years, reductions increased gradually. For example:
- 2023: Some states experienced a 0.6% credit reduction.
- 2024: Reductions increased further in certain states as loans remained outstanding.
- 2025: California and U.S. Virgin Islands remain, with California at a 1.2% reduction.
Key Takeaways for Employers and HR Leaders
- If you operate in California (or the U.S. Virgin Islands), expect a higher FUTA tax bill when filing 2025 returns.
- Build this increased cost into your 2025 payroll budget and cash flow planning.
- When filing your Form 940, ensure you correctly apply the reduced FUTA credit and complete Schedule A if required.
- Monitor updates: if your state repays its loan, credit reductions may revert; if it doesn’t, additional penalty add-ons are possible.
