Profit-Sharing Plans for Small Employers

April 1, 2021

A profit-sharing plan has the same contribution limits as a Simplified Employee Pension (SEP) Plan; however, it gives you more flexibility than a SEP. A profit-sharing plan may:

  • Exclude employees that work less than 1,000 hours, while a SEP excludes employees who work less than 3 of 5 years or have less than $650 in pay.
  • Allow for loans to participants, while a SEP may not make loans.
  • Require vesting that rewards longer-term employees, while a SEP is always 100% vested.
  • Limit distributions, while SEP participants have no restrictions on taking withdrawals.

Profit-sharing plans have a Form 5500 series filing requirement and must meet other administrative requirements compared to a SEP.

Adopt a written plan document

Plans begin with a written document that serves as the foundation for day-to-day plan operations. There are two basic types of plan documents.

  • Individually designed plans are provided by a retirement plan professional and may be designed to meet your specific needs.
  • IRS pre-approved plans are provided by plan professionals or financial institutions and have fewer options.

You have until the due date of your tax return to adopt a profit-sharing plan for that year. You're bound by the terms of the plan document, and your plan document may need to be amended from time to time for new law changes.

Eligibility and participation

An employee becomes a participant in a profit-sharing plan when they meet the plan's eligibility requirements. Employees that are at least age 21 and work 1,000 hours over the 12-month period after being hired become participants on the next plan entry date.

If you have ownership interests in another business, the employees of that business may be eligible to participate in your plan. It may be possible to exclude those related employees, but your plan will need to work with your plan professional to determine if the plan meets coverage testing.


The plan sponsor decides how much to contribute to eligible participants' accounts in the plan. Contributions made to a profit-sharing plan must be allocated among the participants by a formula outlined in the plan document. Many plans decide to give a set percentage of compensation to all participants.

Contributions and forfeitures (nonvested employer contributions of terminated participants) are subject to a per-participant annual limitation. This limit is the lesser of:

  • 100% of the participant's compensation, or
  • $58,000 for 2021

The deduction for the contribution cannot exceed 25% of total eligible compensation.


Vesting is the percentage of the account that the participant owns, based on years of service. A year of vesting service is normally given for each plan year a participant worked 1,000 hours. Vesting schedules range from 100% vesting after 1-3 years, or 20% vesting for each year, leading to 100% ownership after six years.