In the spirit of giving, one way to thank your employees is with profit sharing.
What is profit sharing?
Profit sharing is an employer contribution made to your employees' retirement accounts after the year ends. The contributions are generally made pre-tax.
Important note: Although Roth employer contributions are legally allowed currently, it is not offered by many plans and we will assume they are pre-tax for the rest of this discussion.
For employers, these contributions are usually tax deductible (limited to 25% of eligible compensation), making profit sharing a valuable benefit for employers and employees alike.1 Additionally, if your plan is top heavy any profit sharing contribution will offset the top heavy minimum contribution needed for non-key employees.
As an employer, you decide whether profit sharing is right for your business, and if so, how much you'd like to contribute and in what way. There are many different formulas you can use to allocate your profit sharing contributions. We'll cover the common ones below to help you find one that fits your personal and business goals.
Profit sharing vs. a regular bonus
By offering profit sharing instead of a regular bonus, you can help increase your employees' retirement savings without it being counted towards their taxable income in the year the contribution is made and are not subject to Social Security or Medicare withholding. In this way, profit sharing can be more rewarding to your employees than an outright bonus of the same amount.¹
Take advantage of flexible financial planning
Offering an employer contribution understandably takes some financial forethought. With profit sharing, there's no pressure to make a decision quickly. The flexible deadline for profit sharing plans allow you to decide after the year has ended. As long as you make the contributions before your tax filing deadline (which includes extensions), you will still be able to deduct them on the previous year's tax return. For example, if after reviewing your business financials in February of 2026, you decide you want to make a profit sharing contribution to your employees for 2025, you can do so then and still likely get deductions on your 2025 tax return.1
Understand your type of profit sharing contribution
There are a few different ways you can allocate the profit sharing contribution and you will specify the specific formula in your plan document. Think of it as how you want to divide a set amount of money across all of your eligible employees. Gusto Retirement offers the following options: 1) flat/same dollar amount, 2) pro-rata (aka comp-to-comp), and 3) new comparability.
1. Flat dollar amount: Also referred to as "same dollar amount," this method is the simplest because every employee will receive the same contribution amount. It's calculated by dividing the profit pool amount by the number of eligible employees.
For instance, if the pool is $70,000 and there are 7 employees eligible to participate in the plan, each employee will get $10,000 deposited to their retirement account. Although the individual allocation will be the same across all employees, the percentage of compensation the profit share makes up will vary pretty significantly across employees. ($10,000 to an employee making $40,000 will feel very differently than $10,000 to an employee making $100,000.)
2. Pro rata: Also referred to as “comp-to-comp” this method allocates the profit sharing contribution based on the same percentage of compensation. It's calculated by determining the percentage of compensation for each employee to total compensation of all employees combined. Following this formula, each employee's individual allocation will be the same percentage of their compensation.
For example, if the company's profit sharing pool is $10,000 and the combined compensation of your four eligible employees is $200,000, then each employee would receive a contribution equal to 5% of the employee's salary.
3. New comparability: Also known as the "Grouping" or "Cross-testing" method, this type of profit sharing formula is different from the others because it generally allows you to give a larger dollar amount share to older, higher income individuals than the rest of the employees, as long as the contributions pass certain nondiscrimination tests. By permitting greater disparity of contributions between different groups of employees, new comparability can be a strong fit for business owners who want to contribute more to their own accounts than to their younger, lower-income employees.
Understanding new comparability
Cross-testing is a type of nondiscrimination testing where a profit sharing contribution is converted to a projected benefit at retirement. Using this technique, employers can create different benefit groups. Each group then receives a different contribution. Essentially, new comparability works so that these different contributions made to each employee will result in an equivalent retirement benefit in the future and NHCEs are not discriminated against in the long run. Gusto Retirement will administer the testing and maintenance involved in offering new comparability profit sharing.
New comparability plans may be good for business owners who are older, have higher salaries than other employees, and want to maximize employer contributions to their own accounts.
The new comparability calculation is complex. One step to ensure that allocation is nondiscriminatory requires that a "minimum gateway" contribution of up to 5%2 be given to all Non-Highly Compensated Employees (NHCEs) who receive a profit sharing allocation.
Is new comparability right for you?
New comparability may be a good fit for your small business if:
You'd like to maximize your employer contributions made to owners
Owners are generally older than non-owner employees
Owners receive higher compensation than non-owners
FAQs
What is profit sharing?
Profit sharing is an employer contribution made to employees' retirement accounts, typically after the year ends. They are generally made pre-tax and these contributions are usually tax deductible for employers.1
How is profit sharing different from a regular bonus?
Unlike a regular bonus, profit sharing contributions aren't counted as taxable income for employees in the year they're made. They're also not subject to Social Security or Medicare withholding.¹
What are the different methods for allocating profit sharing?
The three main methods are: flat dollar amount (everyone gets equal amount), pro rata (same percentage of salary), and new comparability (allows different contribution levels based on employee groups).
When is the deadline for making profit sharing contributions?
You generally have until your tax filing deadline (including extensions) to make contributions and still deduct them on the previous year's tax return.
Disclosures
¹ This content is for informational purposes only and is not intended to be taken as tax advice. Please contact a tax professional for further information.
2 The minimum gateway contribution is the lesser of a) 5% or b) 1/3 of the highest allocation rate for any Highly Compensated Employee for the Plan Year.
