Credit reduction state
Summary definition: A state where the maximum tax credit local employers can claim when paying federal unemployment taxes is diminished due to that state owing unpaid federal loans.
What are credit reduction states?
A credit reduction state is a state that borrowed funds from the federal government to cover its unemployment insurance benefits but hasn’t repaid those funds within a specified timeframe.
Under the Federal Unemployment Tax Act (FUTA), employers typically receive a credit of up to 5.4% against the standard 6.0% FUTA tax rate, resulting in a net federal unemployment tax rate of 0.6% per employee.
If, however, a state has an outstanding federal loan balance on January 1 for two consecutive years and fails to repay the full amount by November 10 of the second year, the maximum FUTA credit local employers can claim is reduced by 0.3%. An additional FUTA credit reduction occurs for each subsequent year the amount remains unpaid.
For example, suppose a state borrowed federal funds in 2024 and had an unpaid balance on January 1 in 2025 and 2026. If the state doesn’t repay the full amount by November 10, 2026, the total credit it could claim for the 2026 tax year would be 5.10% (5.40% - 0.30%). If the amount still isn’t repaid by November 10, 2027, the maximum credit for the 2027 tax year is further reduced to 4.80%.
FUTA credit reduction states 2025
As of November 28, 2025, only one state has a FUTA credit reduction. As a result, employers in that state owe more FUTA tax when filing their 2025 tax returns (i.e., Form 940) than those in other states.
| State | 2025 credit reduction | Remaining FUTA tax credit | 2025 FUTA rate | 2025 FUTA tax* |
|---|---|---|---|---|
| California | 1.20% | 4.20% | 1.80% | $126 |
*Per employee (1.80% x $7,000)
If that state still has an unpaid balance by November 10, 2026, the maximum credit will be reduced to 3.9%, and employers will have to pay up to $147 in FUTA taxes (per employee) when filing their 2026 tax returns in 2027.
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