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Profit Sharing: A Guide to Sharing Profits with Employees

Text reads: "Benefits of offering a profit-sharing plan: Increased employee productivity & retention, Profitsharing contributions are taxdeductible to the employer, Costs are proportional to profits, Employees develop a sense of ownership towards the company"

Profit sharing plans let businesses share a certain percentage of the company’s annual profits with their employees. Businesses sharing profits with employees typically do so in cash, payments to retirement plans or by issuing company stocks or bonds. These performance-based employee incentives are usually paid in addition to bonuses and regular salaries. Profit sharing can include all employees or just staff with specific positions, such as managers and executives, making these arrangements a great way to expand benefits for existing workers or attract talented new hires.

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Creating a company profit sharing plan

The amount of money and distribution method for sharing profits with employees varies among companies, with the ultimate purpose to increase productivity through motivation. By offering company profit sharing plans, such as an employee stock ownership plan, you demonstrate to workers that you trust in them to help move your business forward and intend to reward their hard work accordingly. Part of creating the optimal profit sharing plan is laying out what to contribute and who benefits.

Deciding on the share of profit

First of all, profit sharing implies that your company is generating a profit to share with employees. Companies typically decide on a percentage of their total profit to contribute to profit sharing plans. This percentage-based method generally keeps employees motivated because a bigger company profit automatically suggests a larger amount of money for distribution.

Determining who shares profit

Companies typically distribute the shared profit either equally among employees as a percentage of their salaries or based on each person or team’s contribution to the company’s success. Some businesses limit who qualifies for plans aimed at profit sharing for employees, paying out these extra benefits to essential personnel rather than rank-and-file workers.

Crafting profit sharing plan documentation

Once you know how much company profit sharing you aim to do and who to share profit with, it’s time to put your plan to paper. Although you can do this yourself, your business is bound by the document you create so consider consulting with financial and legal professionals with experience in crafting profit sharing plans. The document should outline day-to-day plan operations and include profit sharing calculations, employee eligibility guidelines, a vesting schedule and how your business intends to deposit contributions.

Managing profit sharing plan assets

Two things are required for managing profit sharing plan assets—a trustee and a recordkeeping system. Since profit sharing for employees is basically a retirement plan, using a trust to manage its assets lets a trustee handle contributions, investments and distributions to ensure the plan maintains financial security. Proper record keeping also helps with this stability while assisting your business with regulatory compliance, including the plan’s annual IRS Form 5500 filing. Some professionals who oversee these plans also offer record keeping services for smoother day-to-day operations.

Communicating plans to share profits

Once you’ve laid the groundwork for your company profit sharing plan, you’re ready to communicate the details to employees. A summary plan description (SPD) provides a plain-language recap of how you plan on sharing profits with employees, including specific rights and benefits along with plan features. Likewise, if you change the plan later, make sure to provide affected employees with statements reflecting their total plan benefits, vested benefits and investment values, plus information on directing investments and explanations of diversified investments.

Benefits of sharing profits with employees

Profit sharing for employees offers numerous benefits for your company, including talent retention and making your organization more attractive to new hires. Some of the other key benefits of properly implementing a profit sharing plan include:

  • Increased employee productivity: The main purpose of sharing a company’s profits with employees is typically increased productivity. Knowing that working harder is very likely to increase their revenue usually proves an effective incentive, as opposed to the employees receiving a fixed paycheck regardless of the quality of their work.
  • Employee loyalty: A company that shares some of its profits with its employees is more likely to win worker loyalty. Employees with incomes directly proportional to the organization’s profit generally become more invested in its future success and stay with the company longer. They feel like they have an ownership stake in your company and more control over their financial futures.
  • Tax reductions: Companies can also share profits with employees through 401(k) profit sharing plans. When a company makes contributions to their employees’ 401(k) accounts based on its profits, those contributions count as tax deductions and taxation is deferred for the employee until they’re used upon retirement. This also serves as a motivational tool for employees, as their productivity has a direct impact on their retirement savings.
  • Costs proportional to profits: Sharing profits with employees is also generally beneficial for the organization when profits are low, as the amount of money that needs to be shared decreases proportionally. This makes profit shares an effective tool for small businesses due to lower payments and 401(k) contributions in times when you generate less profit or no profit at all.
  • Employees as consumers: A small business has a significant chance of getting back some of the financial contributions paid to employees since they typically have more money and are more likely to become customers. Depending on the goods or services your company sells, there’s a good chance that employees remain loyal to your organization when they need those respective goods or services. Additionally, happy employees generally spread the word to family and friends, which can potentially provide organic advertising that money just can’t buy.

Profit sharing FAQs

Here are some Frequently Asked Questions regarding profit sharing:

How can you calculate profit sharing?

There are several ways to calculate profit sharing. Here are some of the most common methods:

  • Comp-to-comp:The easiest way to calculate individual profit shares, comp-to-comp profit sharing calculations give employees a contribution that’s proportional to their pay. To calculate, divide each employee’s salary by the total salary pool to determine their percentage, then multiply this figure by the total profit sharing allocation to determine contribution amounts. You can calculate comp-to-comp profit shares in two ways:
    • Pro-rata: Using this method gives each employee a profit share equal to a fixed percentage of their pay. This is easy to calculate, as it requires you to determine only the correct percentage, which is then applied to all eligible employees.
    • Integration: Typically used to reward higher-income employees, integration provides senior workers with a higher share of the profit when compared to lower-income employees. This calculation lets you share a certain amount of profits with all employees and also determine an integration level—a certain percentage of each employee’s taxable wage. You can then award higher bonuses for employees who earn more than the integration level.
  • Uniform points allocation: Some employers prefer to share profits by using certain point values for their employees, usually based upon criteria such as age and seniority within the company. This way who have been with the company for a longer time get a larger share of the profits.

When should your business consider profit sharing?

A company usually decides to share its profits after it has shown a profit for a specific period of time or as part of salary negotiations for a senior employee. Although most companies calculate profit shares after determining annual income and profit, some organizations prefer to pay a share of profits to employees on a quarterly basis. This makes it more likely that the recipients are continually motivated throughout the year.

Do businesses with profit sharing plans have to share profit with employees?

Employers sharing profits with employees must do so according to the terms of the company’s profit sharing plan documentation. Companies, however, have lots of flexibility within those terms to limit contributions during years of volatility or boost contributions during particularly good years.

Are there limits to company profit sharing?

Although there are technically no limits to how much profit your company can share with employees, there are limits to how much it can write off on its taxes. Inflation changes this amount over time, and maximum contributions are set at the lesser of 25% of comp or $58,000 in 2021 and $61,000 in 2022.

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