3750 / How much may an employer deduct for its contributions to a qualified profit sharing or stock bonus plan?

An employer’s deduction for contributions to a profit sharing or stock bonus plan is the greater of (1) 25 percent of the compensation otherwise paid or accrued during the employer’s taxable year to the beneficiaries of the plan, or (2) the amount the employer is required to contribute under Section 401(k) for the year.¹

The amount of annual compensation of each employee taken into account for purposes of this limitation may not exceed $350,000 in 2025 ($345,000 in 2024, $330,000 in 2023, $305,000 in 2022, $290,000 in 2021 and $285,000 in 2020).² Compensation for this purpose is Section 415(c)(3) compensation, which includes elective deferrals under 401(k) and Section 457 plans, salary reduction contributions to Section 125 cafeteria plans, and qualified transportation fringe benefits under IRC Section 132(f).³ In the case of a self-employed person, “earned income” is used instead of “compensation” ( Q 3827).

Contributions, for purposes of the deduction limit, do not include elective deferrals ( Q 3760), and elective deferrals are not themselves subject to any limitation contained in IRC Section 404.⁴

Contributions allocated to life and health insurance are included in the 25 percent limit. A terminating employee’s compensation for the final year is included in the 25 percent only if the employee shares in profits for the final year.⁵ Compensation paid to seasonal and part-time employees who are not eligible to participate in the plan may not be included in calculating the 25 percent limit; neither can compensation paid to employees who terminate before any allocation is made and whose allocations made after termination would be immediately
forfeitable.⁶

Where contributions are made to the trusts of two or more profit sharing or stock bonus plans, the trusts are considered a single trust for purposes of the 25 percent limit.⁷ The limit is applied by aggregating all contributions to such plans and limiting the total to 25 percent of the aggregate compensation of the employees covered by the plans.⁸

Amounts in excess of the 25 percent limit contributed in any year (called a contribution carry-over) may be deducted in succeeding years. Nondeductible contributions are generally subject to a 10 percent excise tax ( Q 3943). For any succeeding year, the deduction for current contributions and contribution carry-overs cannot exceed 25 percent of participating payroll for the taxable year.⁹ Excess contributions made in a year when the trust is exempt may be carried over and deducted in a succeeding year even though the trust is no longer exempt in the succeeding year.¹⁰

The amount of contributions taken into account by profit sharing or stock bonus plans must be reduced by any annual additions in excess of the Section 415 limits.¹¹ The excess amount may not be carried over and deducted in a later year.¹²

Contributions do not need to be made from current or accumulated profits to be deductible.¹³

Restorative payments. Amounts paid to a defined contribution plan as restoration for plan losses that result from a fiduciary breach (or a reasonable risk of liability for a fiduciary breach), are not contributions for purposes of the deduction limit.¹⁴ The same reasoning was applied in a 1998 private ruling where an employer made a restorative contribution to replace plan losses in derivatives to avoid litigation with plan participants.¹⁵ In contrast, payments that are made to a plan to make up for losses due to market fluctuations, but not due to a fiduciary breach, will be treated as contributions subject to the limit, not as restorative payments.¹⁶ The IRS treated payments back to a plan to offset annuity surrender charges as contributions in one ruling,¹⁷ but as restorative payments in another.¹⁸