what is a profit sharing plan 
a profit sharing plan gives employees a share in the profits of a company under this type of retirement plan also known as a deferred profit sharing plan dpsp an employee receives a percentage of a company s profits based on its quarterly or annual earnings it s up to the company to decide how much of its profits it wishes to share there are certain restrictions that regulate this plan understanding profit sharing plansso how does profit sharing work well to start a profit sharing plan is any retirement plan that accepts discretionary employer contributions this means a retirement plan with employee contributions such as a 401 k or something similar is not a profit sharing plan because of the personal contributions because employers set up profit sharing plans businesses decide how much they want to allocate to each employee a company that offers a profit sharing plan adjusts it as needed sometimes making zero contributions in some years in the years when it makes contributions however the company must come up with a set formula for profit allocation 1the most common way for a business to determine the allocation of a profit sharing plan is through the comp to comp method using this calculation an employer first calculates the sum total of all of its employees compensation then to determine what percentage of the profit sharing plan an employee is entitled to the company divides each employee s annual compensation by that total to arrive at the amount due to the employee that percentage is multiplied by the amount of total profits being shared 1the most frequently used formula for a company to determine a profit sharing allocation is called the comp to comp method 1example of a profit sharing planlet s assume a business with only two employees uses a comp to comp method for profit sharing in this case employee a earns 50 000 a year and employee b earns 100 000 a year if the business owner shares 10 of the annual profits and the business earns 100 000 in a fiscal year the company would allocate profit share as follows the contribution limit for a company sharing profits with an employee for 2023 and 73 500 including catch up contributions for those 50 or over during the year 1requirements for a profit sharing plana profit sharing plan is available for a business of any size and a company can establish one even if it already has other retirement plans 1 further a company has a lot of flexibility in how it can implement a profit sharing plan as with a 401 k plan an employer has full discretion over how and when it makes contributions however all companies have to prove that a profit sharing plan does not discriminate in favor of highly compensated employees 2as of 2023 the contribution limit for a company sharing its profits may not exceed the lesser of 100 of your compensation or 66 000 this limit increases to 73 500 for 2023 if you include catch up contributions in addition the amount of an employee s salary that can be considered for a profit sharing plan is limited in 2023 to 330 000 3to implement a profit sharing plan all businesses must fill out an internal revenue service form 5500 and disclose all participants of the plan 45 early withdrawals just as with other retirement plans are subject to penalties though with certain exceptions 6