Profit Sharing Plans

<div class="Section1"><br /> <br /> A profit sharing plan is a plan for sharing company profits with employees. A profit sharing plan need not provide a definite, predetermined formula for determining the amount of profits to be shared. In the absence of a definite formula, there must be recurring and substantial contributions, and contributions must not be made at such times and in such amounts that the plan in operation discriminates in favor of highly compensated employees.<a href="#_ftn1" name="_ftnref1">¹</a> A profit sharing plan may explicitly provide for investment primarily in qualifying employer securities ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3818">3818</a>).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> For an explanation of specific qualification requirements applicable to profit sharing plans, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3751">3751</a>.There are qualification requirements that apply to 401(k) plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3752">3752</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3808">3808</a>) and an employer deduction limit for profit sharing contributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3750">3750</a>).<br /> <br /> A profit sharing plan must provide a definite, predetermined formula for allocating contributions among participants and for distributing accumulated funds to the employees after a fixed number of years (at least two), the attainment of a stated age, or on prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. The allocation formula generally is related to compensation, although age, service, and other factors may be given consideration ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3862">3862</a>). A profit sharing plan cannot provide for allocations or distributions based on predetermined benefits, because such a plan would be a pension plan. Although a profit sharing plan is primarily a plan of deferred compensation, the plan may use funds in an employee&rsquo;s account to provide incidental life or health insurance for the employee or the employee&rsquo;s family ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3830">3830</a>).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> In a private letter ruling,<a href="#_ftn4" name="_ftnref4">⁴</a> the IRS blessed amendment to a profit sharing plan covering collectively bargained employees to allow participants to allocate contributions between HRAs and the plan based on an annual election (a default would apply in the absence of an election).&nbsp;The IRS found that the proposed amendment would not cause the plan to be treated as a 401(k), because it would not create an opportunity for participants to elect cash or to use the contributions to pay for taxable benefits.&nbsp;Therefore, the profit sharing plan would not offer a cash or deferred arrangement&nbsp;under IRC Section 401. The IRS also found that the arrangement would not violate the HRA rules.<br /> <br /> <hr><br /> <br /> A tax-exempt &ldquo;non-profit&rdquo; charitable organization may maintain a profit sharing plan, including a 401(k) plan.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Treas. Reg. &sect; 1.401-1(b)(1)(ii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; ERISA &sect;&sect; 407(b)(1), 407(d)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Treas. Reg. &sect; 1.401-1(b)(1)(ii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Let. Rul. 202023001.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect; 401(k)(4)(B)(i); GCM 38283 (2-15-80).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A profit sharing plan is a defined contribution plan that allows for discretionary employer contributions (as opposed to a money purchase pension plan with a fixed contribution as a percentage of participant compensation). Because employer contributions are discretionary, they can be a means for sharing employer profits with employees and their beneficiaries. All 401(k) plans must be profit sharing plans. A profit sharing plan must provide (1) a definite predetermined formula for allocating contributions and trust earnings among the participants, (2) for periodic valuation of trust assets, and (3) for distribution of the funds accumulated under the plan after a fixed number of years (meaning at least two years), on the attainment of a stated age, or on the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3749">3749</a>).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Profit sharing plans (as opposed to money purchase pension plans) have few restrictions on distributions. The IRS has ruled that a plan could permit participants with at least five years of participation to withdraw all employer contributions (including those made during the last two years).<a href="#_ftn2" name="_ftnref2">²</a> With respect to amounts rolled over from another qualified plan, the receiving profit sharing plan must comply with the &ldquo;fixed number of years&rdquo; requirement without reference to the number of years such amounts accumulated in the previous plan.<a href="#_ftn3" name="_ftnref3">³</a> Where a participant&rsquo;s entire account balance transfers to another qualified plan, the years of participation in both plans may be aggregated.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> It is not necessary that the employer contributes every year, contributes the same amount every year, or contributes in accordance with the same ratio every year. Merely making a single or occasional contribution for employees, however, does not establish a profit-sharing plan. To be a profit-sharing plan, there must be recurring and substantial contributions.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> A provision for offsetting contributions under a profit sharing plan by contributions made to a money purchase pension plan will not prevent either plan from qualifying.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> In a profit sharing plan, an age lower than 65 may be specified as retirement age.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <p style="text-align: center;"><strong>Withdrawal of Contributions</strong></p><br /> If a plan provides that employer contributions are allocated on the basis of employee contributions that may be withdrawn immediately after they are made, the plan will not qualify because such a withdrawal provision &ldquo;could reasonably be expected to result in the manipulation of the allocation and contravention of the definite predetermined allocation formula requirement of Section 1.401-1(b)(1)(ii) of the regulations.&rdquo;<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> If, on the other hand, the withdrawal provision imposes a &ldquo;substantial limitation&rdquo; on the right of a participant to withdraw his or her own contributions, so that the provision &ldquo;cannot reasonably be expected to result in the manipulation of the allocation&rdquo; as described above, this provision will not cause a plan to fail to qualify.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <p style="text-align: center;"><strong>Valuation of Assets</strong></p><br /> If amounts allocated or distributed to a particular participant are to be ascertainable, the plan must provide for a valuation of investments held by the trust at least once a year, on a specified inventory date, in accordance with a method consistently followed and uniformly applied. The fair market value on the inventory date is to be used for this purpose. The respective accounts of the participants are adjusted in accordance with the valuation.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> If a fully insured profit sharing plan provides that all trust assets are to be invested immediately in individual annuity or retirement income contracts, the cash value of which at any particular time is contained in a schedule supplied by the insurance company, the plan need not provide for the periodic valuation of trust investments.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Treas. Reg. &sect; 1.401-1(b)(1)(ii); Rev. Rul. 71-295, 1971-2 CB 184; Rev. Rul. 80-155, 1980-1 CB 84.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Rev. Rul. 68-24, 1968-1 CB 150.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Let. Rul. 8134110.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Let. Rul. 8825130.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; Treas. Reg. &sect; 1.401-1(b)(2).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; Rev. Rul. 81-201, 1981-2 CB 88.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; Rev. Rul. 80-276, 1980-2 CB 131.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp; Rev. Rul. 72-275, 1972-1 CB 109, <em>as modified by</em> Rev. Rul. 74-55, 1974-1 CB 89.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp; Rev. Rul. 74-56, 1974-1 CB 90. <em>See also</em> Let. Rul. 7816022.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp; Rev. Rul. 80-155, 1980-1 CB 84.<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp; Rev. Rul. 73-435, 1973-2 CB 126.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> An employer&rsquo;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&rsquo;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.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> 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).<a href="#_ftn2" name="_ftnref2">²</a> 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).<a href="#_ftn3" name="_ftnref3">³</a> In the case of a self-employed person, &ldquo;earned income&rdquo; is used instead of &ldquo;compensation&rdquo; ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3827">3827</a>).<br /> <br /> Contributions, for purposes of the deduction limit, do not include elective deferrals ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3760">3760</a>), and elective deferrals are not themselves subject to any limitation contained in IRC Section 404.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Contributions allocated to life and health insurance are included in the 25 percent limit. A terminating employee&rsquo;s compensation for the final year is included in the 25 percent only if the employee shares in profits for the final year.<a href="#_ftn5" name="_ftnref5">⁵</a> 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<br /> forfeitable.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> 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.<a href="#_ftn7" name="_ftnref7">⁷</a> 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.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="3943">3943</a>). For any succeeding year, the deduction for current contributions and contribution carry-overs cannot exceed 25 percent of participating payroll for the taxable year.<a href="#_ftn9" name="_ftnref9">⁹</a> 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.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> 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.<a href="#_ftn11" name="_ftnref11">¹¹</a> The excess amount may not be carried over and deducted in a later year.<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> Contributions do not need to be made from current or accumulated profits to be deductible.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> <em>Restorative payments.</em> 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.<a href="#_ftn14" name="_ftnref14">¹⁴</a> 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.<a href="#_ftn15" name="_ftnref15">¹⁵</a> 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.<a href="#_ftn16" name="_ftnref16">¹⁶</a> The IRS treated payments back to a plan to offset annuity surrender charges as contributions in one ruling,<a href="#_ftn17" name="_ftnref17">¹⁷</a> but as restorative payments in another.<a href="#_ftn18" name="_ftnref18">¹⁸</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect; 404(a)(3)(A)(i)(II).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 404(l); Notice 2019-59, Notice 2020-79, Notice 2021-61, Notice 2022-55, Notice 2023-75..<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect; 404(a)(12).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&sect; 404(a)(3), 404(a)(7), 404(a)(9).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; Rev. Rul. 65-295, 1965-2 CB 148.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; <em><em>See Dallas Dental Labs v. Comm</em></em>., 72 TC 117 (1979).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; IRC &sect; 404(a)(3)(A)(iv).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp; Let. Rul. 9635045.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp; Treas. Reg. &sect; 1.404(a)-9(e).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp; Treas. Reg. &sect; 1.404(a)-9(a).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp; IRC &sect; 404(j)(1).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp; Notice 83-10, 1983-1 CB 536, F-1.<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp; IRC &sect; 401(a)(27).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp; Rev. Rul. 2002-45, 2002-2 CB 116. <em><em>See</em> </em>Let. Ruls. 9506048, 9628031.<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp; Let. Rul. 9807028.<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp; Rev. Rul. 2002-45, 2002-2 CB 116.<br /> <br /> <a href="#_ftnref17" name="_ftn17">17</a>.&nbsp; Let. Rul. 200317048.<br /> <br /> <a href="#_ftnref18" name="_ftn18">18</a>.&nbsp; Let. Rul. 200337017.<br /> <br /> </div></div><br />