What you should know about: Profit-Sharing Plans (2024)

Hello and welcome to the IRS Profit-Sharing Plans for Small Employers video. I’m Andrew. The information in this presentationis current as of the day it was presented and shouldn't be considered official guidance.

Let’s get started. A profit-sharing plan is very flexible. You can exclude employees who work less than 1,000 hours per year;exclude employees who are under age 21, use vesting to reward longer-term employees, allow participant loans, and provide lump-sumdistributions. It may also be possible to exclude employees of related employers from your plan.

First, we’ll talk about how to set up your profit-sharing plan. Establishing a profit-sharing plan begins with adopting a written plandocument to serve as the foundation for day-to-day plan operations.

There are two basic document types: An IRS pre-approved plan document and an individually designed plan document.

A pre-approved plan document has been approved by the IRS and includes an opinion letter that shows the level of IRS approval.

Pre-approved plans are available at many financial institutions and through plan professionals.

An individually designed plan is not pre-approved by the IRS and is usually drafted by a retirement planprofessional to meet the specific needs of a plan sponsor.

To establish a plan for a tax year, you have until the due date of the tax return, including extensions,to adopt the plan. You’re also required to share information about the plan with your employees.

Assets are kept in a trust set up with a financial institution. The company that sells you the plan should be able to set up the trust.

Having a good recordkeeping system will be very important going forward. You need to make sure that employees enter the plan timelyto the plan terms you establish, receive proper allocations of contributions and receive distributions according to the plan terms.

All plan documents need to be amended for law changes from time to time.

Pre-approved plans can be amended on your behalf by the document provider and can decrease the number ofamendments you must sign. We recommend maintaining a relationship with your plan provider and checking with them yearly tomake sure your document is up to date.

When you do amend your plan, make sure you select the options in the adoption agreement or plan document that correspond to how you’reoperating your plan. A plan may no longer be qualified if it’s missing required plan amendments.

If your plan is a nonamender, use our Voluntary Correction Program to update your plan and avoid losing yourplan’s preferred tax status. Go to IRS.gov/FixMyPlan to learn how to correct your plan for this error.

You may be asking, “When do employees become participants?” Employees should enter the plan no later than the entry date after theyreach age 21 and work 1,000 hours during the 12-month period after their hire date.

The employer can reduce or remove the eligibility requirements, but the requirements cannot exceed age 21 and 1,000 hours ofservice. Plans that require age 21 and 1,000 hours of service typically have at least two plan entry dates.

Plans with only one entry date have lesser eligibility requirements, like age 20 ½ and 6-months of service.

Additional entry date options may be allowed but are beyond the scope of this video.

Part-time employees who work 1,000 hours and are age 21 are typically eligible to participate in the plan; however,some exclusions may apply based on the employee’s classification.

A plan document can require employees to work 1,000 hours for two years before becomingeligible to enter the plan, but the plan must provide full and immediate vesting of the participant’s account balance.

If you have ownership interests in another business, the employees of that business may be eligible to participate in your plan.

It may be possible to exclude those employees, but you’ll need to account for them each year.

Accounting for employees of a related business is more complex, so you may need a plan professionalto help you design and manage the plan.

Let’s talk about what contributions can be made once you set up your plan.

The plan sponsor decides how much to contribute to the plan. A contribution isn’t required each year and you don’t need profitsto make a contribution.

Contributions are allocated to the participants using a formula in the plan document. Some plans contributea set percentage of compensation for all participants, for example, 10% of their compensation.

Other plans contribute a dollar amount to the plan that’s then allocated to each participant based on their compensationas compared to total compensation. For example, a plan participant who received 2.5% of the total compensationpaid to all eligible participants during the year will receive 2.5% of the dollar amount contributed to the plan.

Make sure you use the plan’s definition of compensation for allocations.

If your plan excludes overtime, bonuses or other forms of compensation, you may need to run a nondiscriminationtest to see if the plan’s compensation definition is discriminatory.

The contributions (including forfeitures) you make to your plan must meet certain limits.

Contribution and forfeiture allocations are subject to a per-participant annual limitation. This limit is the lesser of:100% of the participant's compensation, or $58,000 for 2021.

Deductions for contributions made to a profit-sharing plan cannot exceed 25% of the compensation paidduring the year to all eligible participants.

And remember that a forfeiture is the non-vested portion of a terminated participant’s account balance that’s leftafter a distribution. Check your plan document to make sure forfeitures are being properly allocated to participant accounts.

Be aware that you can’t maintain a plan that’s discriminatory. Plans must provide substantive benefits for rank-and-file employees,not just owners and managers. Nondiscrimination rules compare participation and contributions for rank-and-fileemployees to owners and managers.

Plans that allocate a uniform percentage of total compensation to each participant, including those participants not employedon the last day, should satisfy the nondiscrimination requirement.

If you exclude certain types of compensation, or require 1,000 hours of service or employment on theon the last day to participate in the allocation, you may need to have a plan professional make sure your plan is not discriminatory.

Let’s move on to the vesting requirements in profit-sharing plans.

Vesting is the percentage of the account that the plan participant owns, based on years of service.

Most plans require participants to work 1,000 hours during the plan year to earn a year of vesting service,but an employer can require less or no service to earn a year of vesting service.

Your plan is required to comply with one of two basic vesting schedules:The first is a 3-year cliff vesting schedule, which is 0% vesting for the first 2 years of service and 100% vesting after 3 years ofThe second is a 6-year graded vesting schedule, which is 0% vesting after one year of service,20% vesting with two years, 40% with three years, 60% with four, 80% with five, then 100% vesting with six years of service.

A plan with a different vesting schedule must vest at least as quickly as one of these two schedules each year.

Our next topic is distribution options available for profit-sharing plans. The amount available for distribution from a profit-sharing planis the participant’s vested account balance. Some plan documents allow distributions when participants reach normal retirement ageor stop working for the employer. Other plans allow distributions at a certain age.

Distributions to participants from profit sharing plans are typically:taken in a lump sum, or rolled over to an IRA or another employer's retirement plan. Some plans may allow for periodicdistributions, annuities or other lifetime income distribution options.

A profit-sharing plan can also allow participants to borrow from their plan account.

These loans are generally limited to the lesser of 50% of the participant’s account balance or $50,000.

Loans are typically limited to five years and must be repaid with equal payments made at least quarterly.

It may help you to know the most common problems we find in profit-sharing plans. They are:Not including employees who meet the plan’s eligibility requirements; not accounting for employees who work for a related business;not using the definition of compensation in the plan document, and not amending the plan for required law changes.

If you have a profit-sharing plan, you may need to file certain returns. Depending on the number and type of participants covered,most profit-sharing plans must file one of the following forms:Form 5500, Annual Return/Report of Employee Benefit Plan,Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan, orForm 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement PlanYou can file each of these returns electronically using the Department of Labor’s EFAST2 filing system.

One-participant plans that file Form 5500-EZ don’t have to file for any plan year when assets do not exceed $250,000;however, a final return must be filed when the plan is terminated.

You should use Form 1099-R to report distributions and rollovers from a retirement plan.

Form 8955-SSA is the Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits.

The information reported is shared with plan participants when they file for Social Security benefits.

The IRS provides several profit-sharing plan resources:Publication 3998, Choosing a Retirement Solution for Your Small Business, provides a comparison of different retirement plan options.

If you visit IRS.gov/retirement and select “Types of Retirement Plans,” then “Profit-sharing plans,” you’ll find a wealth of helpfulCheck out IRS.gov/SmallPlans for information dedicated to small employers looking to find, maintain or fix a retirement plan.

On IRSVideos.gov, you’ll find a 30-minute video on the types of plans available to small employers and self-employed individuals.

We also have shorter videos on the types of plans that small employers may want to adopt.

Finally, don’t forget to sign up for our retirement plan newsletter at IRS.gov/RetirementNews -and send your questions or feedback about this video to tege.outreach@irs.gov. Thanks for watching.