Profit Sharing

The discretionary lever inside the plan.

A profit-sharing contribution is the part of a qualified plan the company can dial up, dial down, or skip in any given year. The 401(k) deferral and the safe-harbor match get most of the attention, but the profit-sharing piece is where the design choices get interesting. The allocation formula decides whose account the dollars end up in.

Three common formulas

• Pro-rata. Every eligible employee gets the same percentage of compensation. Simple to administer, easy to explain. The owner and the front-desk hire get the same rate.
• Integrated (Social Security / permitted disparity). Contributions are higher on pay above the Social Security wage base ($184,500 for 2026) than below it. Tilts dollars toward higher earners while staying inside IRS rules.
• New comparability (cross-tested). Employees are grouped (often by job class), and each group gets a different contribution rate. Testing is run on the projected benefit at retirement rather than the current-year contribution, which often lets the formula direct more to owners and key employees.

Why new comparability often fits owner-led businesses

In a typical closely-held company, the owners are older and higher-paid than the rank-and-file. A cross-tested formula uses that age gap (older participants need fewer years of contributions to reach the same projected benefit) to justify a much larger allocation to the owner group while still passing the IRS general test.

An illustrative 2026 example, owner age 55, two staff ages 30 and 35:

• Owner: 25%+ of pay, up to the $72,000 annual addition cap
• Staff: a “gateway” minimum, often around 5% of pay

The exact percentages depend on the demographics. The point is that the same dollar of company contribution can put significantly more in the owner’s account under new comparability than under pro-rata. Whether it passes testing depends on the workforce; we run the numbers before committing.

The mechanics

• Discretionary year by year. The contribution amount can change with the business. A great year funds a big contribution; a lean year funds nothing.
• Deadline. Profit-sharing contributions can generally be made up to the extended due date of the company’s tax return for the year being credited.
• Vesting. Profit-sharing dollars can be subject to a vesting schedule (often 3-year cliff or 6-year graded), which makes them a retention tool, not just a tax move.
• Trust and recordkeeping. The dollars sit in the qualified plan trust, allocated by participant. The recordkeeper tracks balances, vesting, and distributions.

Pitfalls

• Letting the formula go stale. The optimal allocation method drifts as headcount, ages, and payroll change. A formula that fit five years ago may be leaving money on the table or failing testing now.
• Not coordinating with the 401(k) match. The safe-harbor match, the profit-sharing contribution, and the testing all interact. Designing them in isolation produces conflicts.
• Ignoring vesting. Immediate vesting on profit-sharing throws away a useful retention lever. A reasonable vesting schedule (within IRS limits) keeps the dollars working for the company.
• Underfunding the gateway. Cross-tested plans require a minimum contribution to non-HCEs (often 5% of pay). Skipping or skimping breaks the test.