Do I Pay Federal Unemployment if I Am a Sole Proprietor?

Federal and state unemployment taxes provide a social safety net for struggling workers.
Federal and state unemployment taxes provide a social safety net for struggling workers. (Image: Jupiterimages/BananaStock/Getty Images)

As a sole proprietor, you are responsible for paying both federal and state unemployment taxes on your payroll. Your tax liability is based on your payroll rather than on the ownership structure of your company. You would owe the same unemployment taxes whether your business was set up as a corporation, a partnership or a sole proprietorship.

Federal Unemployment Tax

Federal unemployment tax is a tax collected by the IRS from all employers. It is different from state unemployment tax, which is collected by state unemployment agencies from employers in their particular state. Federal legislation mandates that state agencies collect unemployment taxes and set up state unemployment funds; however, the federal government also collects its own unemployment tax and redistributes it back to the states to help state unemployment agencies pay for administrative costs associated with operating their programs.

Federal Unemployment Tax Rates

The federal unemployment tax rate is 6.2 percent of the employee wages that are subject to this tax. However employers are allowed to offset their federal employment tax liability with payments made to state unemployment agencies. If an employer has already paid his state more than he would owe to the federal government using the 6.2 percent rate, then he is only liable to pay the IRS .8 percent of the wages that are subject to this tax.

Federal Unemployment Tax Maximum

The maximum amount on which any employer must pay federal unemployment tax is $7,000 per employee. This tax structure differs from that of most states, which do not have maximum payroll limits for unemployment taxes. Because the taxable basis for state unemployment tax is usually higher than the taxable basis for federal unemployment tax, most employers who pay state unemployment tax easily reach the maximum amount of credit they are allowed to take to offset federal unemployment taxes, making them eligible to pay the lower rate of .8 percent.

Reducing Federal Unemployment Tax

You will pay less money in federal unemployment tax if you hire fewer workers for a greater number of hours each than if you hire a greater number of workers for fewer hours each. Because you do not owe federal unemployment tax on payroll exceeding $7,000 per employee, if you hire five workers and pay them ea &7,000 during a calendar year then you will owe federal employment taxes on $35,000 worth of payroll, but if you have only one employee earning $35,000 then you will owe federal unemployment tax on only $7,000 worth of payroll.

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