businessBusiness Coachingbusiness growthconsultantFinanceProcess Improvementsmall-businessWhat Is A Profit-Sharing Plan And How To Set One Up

November 15, 2021by Mikerash0
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As organizations struggle to find, attract and retain employees in the wake of the Great Resignation, establishing a reputable workplace is more important than ever! Contrary to popular belief, competitive compensation is not the only thing that drives employees to a particular company, in fact, a strong benefit plan can set you apart from your competitors.

Naturally, small to midsize businesses possess greater flexibility when it comes to employer-provided benefits, therefore, learning the ins and outs of each is crucial when deciding which benefits are best to offer.

Here at MCDA CCG we receive a significant number of questions regarding profit-sharing plans, so we have decided to take to our blog to provide further insight.

Keep reading to learn more!

What Is a Profit Sharing Plan?

A profit-sharing plan is a type of defined contribution plan where companies can help their employees save for retirement by giving them a share in the profits of a company.

As the name suggests, an employee receives a percentage of a company’s profits based on its quarterly or annual earnings under this plan.

The business determines how much to contribute to the plan, at select times, often dependent on the company’s success. For example, a business may determine to contribute nothing to the plan after an unavailing year.

However, when profits are being shared, every company must determine a formula for distribution. The comp-to-comp method is the most common method of profit allocation.

Definition and Example of Profit-Sharing Plans

Profit-sharing plans are a way for a company to share profits with certain employees. Company contributions are discretionary and the business decides the amount it will put into the plan from year to year. As mentioned above, the company can even decide not to contribute at all.


Both small and larger businesses will find the additional flexibility worthwhile. Furthermore, a profit-sharing plan aligns the financial well-being of workers with the company’s success.

Unlike 401(k) plan participants, workers with profit-sharing plans don’t make their own contributions. A company can offer other types of retirement plans, such as a 401(k), along with a profit-sharing plan.

Furthermore, a company can legally exclude certain employees from the plan depending on its terms.

How Profit Sharing Plans Work:

Employees can receive their shares of profits in the form of cash or stock, and contributions are usually made to a qualified tax-deferred retirement account. The cash is taxed at ordinary income rates.

What Are the Benefits of Profit Sharing Plans?

Profit sharing plans benefit both your employees and your company.

Employer-sponsored retirement plans are one of the most desired benefits a company could offer, and profit sharing plans are tax-advantaged.

Providing a retirement savings plan is an excellent way to encourage employee retention, ensuring that highly skilled, highly experienced individuals stay at your company.

Profit sharing in particular provides a sense of ownership – employees are directly benefited when the company succeeds.

Profit-Sharing Plan VS. 401(k) Plans

What are the differences between a profit sharing plan and a 401k?

Profit Sharing Plan

  • A company contributes a percentage of its profits into an employee’s plan.
  • A company’s contributions are discretionary depending upon whether it’s profitable.


  • Employees make contributions to their own plans via payroll deductions.
  • Companies have the option of matching their employees’ contributions, to a limit.

Profit-sharing plans and 401(k)s both help workers save and plan for retirement, but they are structured differently. While profit-sharing plans are fully funded by the employer, 401(k) plans are funded through the employee’s own earnings.

Both types of plans have without rewards for businesses, as well. When your employees are happy, they are more likely to stay with your company; plus, generous employer funded plans can attract new employees.

How Can I Set a Profit Sharing Plan Up?

A profit sharing plan is a flexible option, available to businesses of any size. Profit sharing plans can exist in alongside with existing retirement plans, and a company does not necessarily have to be profitable to establish one.

Getting started with a profit sharing plan is simple.

To apply, a business owner must:

  1. Fill out the IRS Form 5500 and list all participants. Variations of Form 5500 can be selected, depending on the number of plan participants.
  2. The employer maintaining the plan must file the form electronically before the due date. During setup, companies must prove that the plan does not favor highly compensated employees. Form 5500 must be filed annually.

We must note that non-profit organizations are the only exception to profit sharing eligibility because nonprofits are not structured to be profitable. Even if a for-profit company is not profitable in a certain time period, the company is structured to make a profit and is, therefore, qualified to establish profit sharing.


Effectively carrying out your business finances – whether it be employer-sponsored retirement plans or routine bookkeeping tasks – requires constant attention. In fact, our experienced professionals come across many business owners who don’t have time to do it all themselves, yet can’t afford a full time employee/team.

Here at MCDA CCG, we provide quality, flexible financial services to fit your organization’s unique needs, schedule, and size – all while saving you the costs of an internal team.

We can work with you to help identify which employer sponsored benefits(s) are right for you at this moment, then we can help to properly structure your plans in accordance with the latest laws and regulations.

Interested in learning more? Give our office -headquartered in Placentia, Orange County, California, a call today to speak with one of our financial experts in a free, no obligation call!

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