What is Credit Reduction in Form 940?

A state that hasn't repaid money it borrowed from the federal government to pay unemployment benefits is a “credit reduction state.” If an employer pays wages subject to the unemployment tax laws of a credit reduction state, that employer must pay additional federal unemployment tax when filing its Form 940.

The credit reduction rate for the tax year 2023 has been set at 0.6% for California, Connecticut, Illinois, and New York, while for the U.S. Virgin Islands, it is 3.6%. For the tax year 2024, the credit reduction rate has been increased to 0.9% for California, Connecticut, and New York and 4.2% for the U.S. Virgin Islands.