Why Are You Paying Additional FUTA Taxes Every Year?

In 2026, California remains the only U.S. state (alongside the U.S. Virgin Islands) still carrying significant debt from a federal loan taken out during the COVID-19 pandemic to cover unemployment benefits. Because the state has failed to repay this balance, California employers are subject to higher federal payroll taxes through an automatic mechanism known as a FUTA credit reduction. 

The Core Issue

  • The Debt: In June 2020, California began borrowing billions from the federal government to replenish its Unemployment Insurance (UI) Fund as claims surged during pandemic lockdowns.

  • The Default: While most states used federal stimulus funds to repay these loans by 2022, California lawmakers used that stimulus money for other priorities like infrastructure and homelessness programs.

  • Current Status: As of 2026, California's outstanding balance is approximately $21 billion, with some projections suggesting it could grow to $23.7 billion by the end of the year due to benefit payouts exceeding tax collections. 

How This Affects FUTA Taxes

Under federal law, if a state has an outstanding loan for two or more consecutive years, the 5.4% credit typically granted to employers against the standard 6.0% FUTA tax is reduced. 

  • Escalating Costs: This credit is reduced by 0.3% every year the loan remains unpaid.

  • 2025 Tax Year (Paid in 2026): The total credit reduction has reached 1.2%, resulting in an effective FUTA tax rate of 1.8%.

    • This equals $126 per employee annually, which is $84 more than the standard $42 paid in debt-free states.

  • 2026 Tax Year: The rate is expected to increase further to 2.1% ($147 per employee). 

Future Risks

  • Potential Benefit Cost Rate (BCR) Add-on: If a loan remains unpaid for five years, the federal government can impose an additional "BCR" surcharge. While California received a waiver for this in 2025, employers could face a much steeper tax hike—potentially over $400 per employee—if future waivers are denied.

  • Longevity: Without a significant policy change or massive payment from the state's General Fund, experts project it could take until at least 2030 or 2031 for the debt to be fully cleared through these employer surcharges. 

California redirected federal stimulus funds designed to support employment and hiring during the pandemic. Later, California defaulted on loans from the Federal Government, and as a result, California employers are being assessed additional payroll taxes annually, until federal loans to California are repaid.

Robert Martin