Profit sharing plan

What a profit sharing plan is

A profit sharing plan is a defined contribution plan funded by discretionary employer contributions. Despite the name, the business does not need profits to contribute, and it can skip a year. Most small and mid-sized employers do not run a separate plan. They add a profit sharing feature to their 401(k), so employee deferrals, any match and the profit sharing contribution sit in one plan.

The plan document must state how the contribution is divided. Common formulas are pro rata (the same percentage of pay for everyone), permitted disparity (a higher rate on pay above the Social Security wage base) and new comparability (different rates for different groups, proven fair through testing).

Why it matters to employers

It is the most flexible employer contribution. You can decide the amount after year end, as late as your tax filing deadline including extensions, and still deduct it for that year. The deduction limit is 25% of the total compensation of eligible participants.

Example with 2026 figures

A company contributes 5% of pay pro rata. An employee earning $70,000 receives $3,500. For an owner, pay counts only up to $360,000 in 2026, so 5% is $18,000. Each person’s total from all sources (deferrals, match and profit sharing) cannot exceed $72,000 in 2026, not counting catch-up contributions.

Common mistakes

• Dividing the contribution in a way that does not match the formula in the plan document.

• Leaving out employees who met the plan’s conditions, such as a 1,000-hour or last-day rule.

• Assuming a safe harbor 401(k) stays free of testing. A profit sharing contribution is tested for nondiscrimination under separate rules.

• Applying a vesting schedule incorrectly when employees leave.