Profit sharing plans are a form of compensation that companies pay to their employees. A profit sharing plan is basically an incentive plan wherein a portion of the company’s profits are paid to its employees, usually on an annual basis.
Profit sharing is a way for an organization to provide employee recognition, and is often used as a way to attract or keep employees. Small businesses typically utilize profit sharing plans more than larger businesses. The rules governing profit sharing plans may vary from state to state.
Usually a company will set aside some portion of its pre-tax profits in a pool of funds that is to be distributed amongst eligible employees. The amount distributed to each individual employee may then be weighed against several factors, such as the employee’s base salary.
Thus, employees with a higher base pay may receive higher amounts from the pool of funds than other employees. In general most tax laws allow businesses to contribute a maximum limit of 15% of the employee’s salary towards profit sharing benefits.
Depending on the way that the profit sharing bonuses are distributed, they may or may not be subject to income tax for the employee. Profit sharing plans generally come in two forms:
- Cash Distribution Plans: End-of-the-year cash bonus payouts are immediately subject to income tax
- Deferred Compensation Plans: Instead of a cash payout, the profit sharing bonuses are held in separate accounts for each individual employee. The money in the accounts are not taxable income and may even be qualified to earn tax-deferred interest
With deferred compensation plans, employees are sometimes also given other benefits such as stock options. The employees are not allowed to withdraw funds from their profit sharing accounts except according to specified conditions, such as working for a predetermined amount of time with the company. 401 (k) plans are a common example of a deferred compensation plan.
Thus, employees sometimes prefer deferred compensation plans over cash distribution plans, as deferred compensation plans are not immediately taxable.
Two legal issues that are commonly associated with profit sharing plans are:
- Vesting: Employees may only receive profit sharing benefits or access their deferred compensation plans after they have “vested”. Employee vesting occurs after well-defined conditions have been fulfilled, such as after the employee has worked a certain number of years or after they have retired. Vesting conditions may sometimes be negotiated in a contract or may be defined by statute
- Forfeiture: Forfeiture of profit sharing benefits occurs when an employee leaves the company before they are vested. If forfeiture occurs, any funds in their accounts wiProfit Sharing Plan Lawyersll likely be distributed to other eligible employees. Issues may arise if the employee is fired just prior to vesting.
Other legal issues that may arise in connection with profit sharing include disputes over eligibility for such plans or improper withholding of profit sharing funds. An employer might be held liable if they have negotiated a profit sharing plan with an employee but fail to render payments as promised. Such violations are usually treated similarly to a breach of contract.
Profit sharing plans can be beneficial both for the company and the employees. However, profit sharing plans should be carefully negotiated so that they provide benefits in a manner that conforms to state and federal laws. An experienced employment lawyer may help when dealing with profit sharing. Your attorney may be able to help you negotiate your plan or resolve any potential issues that may arise. A lawyer can also create a contract for the profit sharing arrangement.