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Choosing A Profit Sharing Plan

Employers contribute on behalf of eligible employees. The amount is discretionary from year to year, and can be as high as 25% of total 'eligible' payroll for eligible employees.

  • Many different allocation techniques are available, allowing plan design to favor certain groups of employees.

  • Contributions are not included in employees' income for income tax or Social Security tax purposes.

  • Earnings in the plan grow on a tax-deferred basis.
    The plan enhances the company's ability to attract and retain 'top-notch' employees.

  • A good choice for young companies with erratic or unpredictable cash flow.

Highlights: Profit Sharing Plan

Guess what.  You don’t need profits in order to make contributions to a profit-sharing plan.  Of course, having a profit would probably make it easier to actually contribute something.

Contributions to a profit-sharing plan are discretionary.  There is no set amount that you need to make.  If you can afford to make some amount of contributions to the plan, then go ahead. 

If you do make contributions, you will need to have a set formula for determining how the contributions are divided.  This money goes into a separate account for each employee.

One common method for determining each participant’s allocation in a profit-sharing plan is the “comp-to comp” method.  Under this method, the employer calculates the sum of all of its employees’ compensation (the total “comp”).  To determine each employee’s allocation of the employer’s contribution, you divide the employee’s compensation (employee “comp”) by the total comp.  You then multiply each employee’s fraction by the amount of the employer contribution.  Using this method will get you each employee’s share of the employer contribution.

If you establish a profit-sharing plan, you:

  • Can have other retirement plans.

  • Can be a business of any size.

  • Need to annually file a Form 5500.

As with 401(k) plans, you can make a profit-sharing plan as simple or as complex as you want to.  Pre-approved profit-sharing plans are available to cut down on administrative headaches.

Information List

Pros and Cons:

  • Greater flexibility in contributions – contributions are strictly discretionary.

  • Good plan if cash flow is an issue.

  • Administrative costs may be higher than under more basic arrangements.

  • Need to test that benefits do not discriminate in favor of the highly compensated employees.

Who Contributes:  Employer contributions only.

Contribution Limits:  The lesser of 25% of compensation or $45,000 in 2007 ($46,000 in 2008 and subject to cost-of-living adjustments for later years).

Participant Loans:  Permitted.

In-Service Withdrawals:  Yes, but subject to possible 10% penalty if under age 59-1/2.

Filing Requirements:  Annual filing of Form 5500 may or may not be required.

Who May Not Have To File
You do not have to file Form 5500-EZ (or Form 5500) for a plan year (other than the final plan year) that begins on or after January 1, 2007, if you meet the five conditions above and you have one or more one-participant plans that separately or together had total assets of $250,000 or less at the end of that plan year.

Example for plan years beginning on or after January 1, 2007. If total assets in a plan (or in two or date more plans, separately or together), that otherwise
satisfies the requirements for filing the Form 5500-EZ, exceeded $250,000 at the end of the 2007 plan year, a Form 5500-EZ must be filed for the 2007 plan year.

Final plan year. All one-participant plans should file the Form 5500-EZ for their final plan year indicating that all assets have been distributed. The final plan year is the year in which distribution of all plan assets is completed. Check the “final return” box at the top of Form 5500-EZ if all assets under the plan(s) (including insurance/annuity contracts) have been distributed to the participants and beneficiaries or distributed to another plan.

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Source: www.IRS.gov

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last reviewed and/or updated on Friday, July 03, 2015 05:21 PM


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