A profit sharing plan is an employer-funded, discretionary defined contribution retirement plan: the employer decides each year whether to contribute and how much, and employees do not put in their own money. For 2026, the total that can be added to any one participant’s account is capped at $72,000 under Internal Revenue Code section 415(c) (Source: IRS Notice 2025-67).
A profit sharing plan is an employer-funded defined contribution retirement plan that accepts flexible, discretionary contributions. Employees do not contribute their own pay. For 2026, total annual additions to one participant’s account are limited to $72,000 under section 415(c), and the employer’s tax deduction is separately capped at 25% of eligible compensation under section 404 (Source: IRS Notice 2025-67; IRS Publication 560).
What is a profit sharing plan?
A profit sharing plan is an employer-funded, discretionary defined contribution retirement plan in which the employer places contributions into a separate account for each eligible employee. Employees do not make their own contributions, and the money does not have to come from company profits. The employer chooses the amount each year and can skip a year entirely (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
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Despite the name, contributions are not tied to actual profits. The IRS allows a business to contribute whether or not it recorded a profit, so the term describes the plan structure, not a funding rule (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
In its pure form the plan holds employer money only. If a business adds a salary deferral feature that lets employees contribute their own pay, the IRS classifies it as a 401(k) plan, which is why many employer plans are combined 401(k) profit sharing plans (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
How does a profit sharing plan work?
A profit sharing plan works through a written plan document that sets eligibility and a definite predetermined formula for allocating contributions (Source: 26 CFR 1.401-1(b)(1)(ii)). Each year the employer decides the total contribution, which is split across participant accounts by that formula. Because contributions are discretionary, the employer can vary or skip them year to year.
Running a profit sharing plan generally follows these steps:
- Adopt a written plan document naming an allocation formula and eligibility rules.
- Decide each year whether to contribute and how much, within the applicable limits.
- Allocate the total contribution to participant accounts using the plan formula.
- Apply the plan’s vesting schedule and file required returns (such as Form 5500).
Forfeitures from participants who leave before they are fully vested are reallocated under the plan and count toward the receiving participant’s section 415(c) annual additions cap (Source: IRS Publication 560, 2025).
What allocation formulas can a profit sharing plan use?
A profit sharing plan can allocate the employer’s contribution using several IRS-permitted formulas: pro-rata (comp-to-comp), flat dollar, permitted disparity (integrated with Social Security), age-weighted, and new comparability (cross-tested). The plan must state a definite predetermined formula, and any design must still pass nondiscrimination testing (Source: 26 CFR 1.401-1(b)(1)(ii); 26 U.S.C. 401(a)(4)).
| Formula | How it allocates | Often used when |
|---|---|---|
| Pro-rata (comp-to-comp) | Same percentage of pay for every eligible participant | The employer wants a simple, uniform allocation |
| Flat dollar | Equal dollar amount to each participant | The employer wants an identical share for all |
| Permitted disparity (integrated) | Higher rate on pay above the Social Security wage base | The employer wants to coordinate with Social Security |
| Age-weighted | Weights allocations by age and years to retirement | Older participants are targeted for larger amounts |
| New comparability (cross-tested) | Groups participants and tests benefits by class | The employer wants flexibility across employee groups |
A qualified plan generally must not discriminate in favor of highly compensated employees (Source: 26 U.S.C. 401(a)(4)). A top-heavy plan, meaning key employees hold more than 60% of plan assets, must generally provide a minimum contribution for non-key employees; the 2026 key employee officer threshold is $235,000 (Source: 26 U.S.C. 416; IRS Notice 2025-67).
How much can be contributed to a profit sharing plan in 2026?
For 2026, total annual additions to one participant’s profit sharing account are limited to $72,000, or 100% of that person’s compensation if lower, under section 415(c) (Source: IRS Notice 2025-67; 26 U.S.C. 415(c)). Annual additions include employer contributions and reallocated forfeitures. Compensation counted per participant is itself capped at $360,000 under section 401(a)(17) (Source: IRS Notice 2025-67).
| Limit (2026) | Amount | Code section |
|---|---|---|
| Annual additions per participant | $72,000 (or 100% of compensation) | 415(c) |
| Employer deduction cap | 25% of eligible compensation | 404 |
| Compensation counted per participant | $360,000 | 401(a)(17) |
| 401(k) elective deferral (if combined) | $24,500 | 402(g) |
| Highly compensated employee threshold | $160,000 | 414(q) |
| Key employee (top-heavy) officer | $235,000 | 416(i) |
Source for all figures in this table: IRS Notice 2025-67, “2026 Amounts Relating to Retirement Plans and IRAs,” effective January 1, 2026.
What is the 25% rule for profit sharing plans?
The 25% rule is the employer deduction limit under section 404: a business can generally deduct profit sharing contributions up to 25% of the compensation paid to eligible participants for the year (Source: IRS Publication 560, 2025). This deduction cap is separate from the $72,000 section 415(c) annual additions cap, and both apply at once. Excess contributions above the 25% limit can generally carry over to later years.
A worked example shows which limit binds. If a participant earns $200,000 in eligible compensation in 2026, the 25% figure applied to that pay is $50,000, which is below the $72,000 annual additions ceiling, so the deduction limit binds first. For a more highly paid participant, the $72,000 section 415(c) cap can bind first instead. Employee elective deferrals in a combined 401(k) profit sharing plan do not count against the 25% deduction limit (Source: IRS Publication 560, 2025).
Does the catch-up contribution raise the profit sharing limit?
No. Catch-up contributions do not raise the profit sharing limit. Catch-ups apply only to 401(k) elective deferrals, which employees make from their own pay, and a pure profit sharing plan has no employee deferrals. The correct 2026 employer profit sharing ceiling is the $72,000 section 415(c) annual additions cap, not the $80,000 or $83,250 figures some sources cite (Source: IRS Notice 2025-67; 26 U.S.C. 414(v)).
Those larger numbers combine the $72,000 cap with 401(k) catch-up amounts ($8,000 at age 50 and up, or $11,250 for ages 60 to 63 in 2026). Catch-ups apply only to participants who make elective deferrals in a 401(k) or combined plan, never to employer-only profit sharing contributions (Source: IRS Notice 2025-67; 26 U.S.C. 414(v)).
Profit sharing plan vs 401(k): what is the difference?
The core difference is who contributes: a profit sharing plan holds only discretionary employer contributions, while a 401(k) adds a salary deferral feature that lets employees contribute their own pay (up to $24,500 in 2026). When a profit sharing plan includes that feature, the IRS treats it as a 401(k), and many employers run the two together as one combined plan (Source: IRS Notice 2025-67; IRS, “Choosing a retirement plan”).
| Feature | Profit sharing plan | 401(k) plan |
|---|---|---|
| Who contributes | Employer only, discretionary | Employee deferrals, often plus employer contributions |
| 2026 employee deferral limit | Not applicable | $24,500 |
| 2026 annual additions cap per participant | $72,000 | $72,000 |
| Contribution flexibility | Employer can vary or skip year to year | Employees choose deferral rate; employer match may be fixed |
Both plan types share the same $72,000 section 415(c) annual additions cap for 2026 because both are defined contribution plans (Source: IRS Notice 2025-67). Combining a profit sharing feature with 401(k) deferrals is one way employers direct more into a participant’s account within that single cap.
How is a profit sharing plan taxed and when can you withdraw?
Money in a traditional profit sharing plan grows tax-deferred, and distributions are generally taxed as ordinary income when taken (Source: IRS Publication 575). Withdrawals before age 59 and a half are generally subject to an additional 10% tax unless an exception applies (Source: IRS Topic No. 558; 26 U.S.C. 72(t)). Employer contributions vest under the plan’s schedule, and vested balances can be rolled over to an IRA or another employer plan.
Large pre-tax balances can raise taxable income later, affecting Medicare premiums, the taxation of Social Security, and the net investment income tax. They also drive future required minimum distributions, which begin at age 73 (age 75 for those born in 1960 or later).
Some savers evaluate whether converting pre-tax balances to a Roth account fits their situation, which can change the timing of tax. Q3 Advisors offers a Roth conversion service and guidance on how much to convert to Roth. Whether any conversion is appropriate depends on individual facts and is a decision for a qualified professional.
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Q3 Advisors is a registered investment adviser focused on retirement tax planning. This page is educational and is not advice; consult a qualified professional.
Frequently asked questions
What is a profit sharing plan?
A profit sharing plan is an employer-funded defined contribution retirement plan that accepts discretionary employer contributions, placed in a separate account for each employee. The employer decides each year whether to contribute and how much, employees do not contribute their own pay, and the money does not have to come from company profits (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
What is the maximum profit sharing contribution for 2026?
For 2026, total annual additions to one participant’s profit sharing account are limited to $72,000, or 100% of compensation if lower, under section 415(c) (Source: IRS Notice 2025-67). Separately, the employer’s deduction is capped at 25% of eligible compensation under section 404. Catch-up amounts do not raise the employer-only profit sharing ceiling.
Is a profit sharing plan the same as a 401(k)?
No. A profit sharing plan holds only discretionary employer contributions. A 401(k) plan adds a salary deferral feature that lets employees contribute their own pay, up to $24,500 in 2026. When a profit sharing plan includes that deferral feature, the IRS classifies it as a 401(k), and many employers combine the two (Source: IRS Notice 2025-67; IRS, “Choosing a retirement plan”).
Do profit sharing contributions have to come from profits?
No. Although the name suggests profits, a business can make profit sharing plan contributions whether or not it earned a profit for the year (Source: IRS, “Choosing a retirement plan: Profit sharing plan”). The contributions remain discretionary, so the employer chooses the amount each year within the applicable IRS limits.
How is profit sharing taxed?
Distributions from a traditional profit sharing plan are generally taxed as ordinary income when taken (Source: IRS Publication 575), and withdrawals before age 59 and a half are generally subject to an additional 10% tax unless an exception applies (Source: IRS Topic No. 558; 26 U.S.C. 72(t)). The exact result depends on the account type and the individual’s circumstances.
Can an employee contribute to a profit sharing plan?
No. In a pure profit sharing plan, only the employer contributes; employees do not make their own contributions. Employees can defer their own pay only if the employer adds a 401(k) salary deferral feature, at which point the arrangement is a combined 401(k) profit sharing plan (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
When can you withdraw from a profit sharing plan?
Withdrawals are generally allowed after a triggering event such as reaching age 59 and a half, separating from service, disability, or plan termination, subject to the plan’s terms. Distributions before age 59 and a half generally face an additional 10% tax unless an exception applies (Source: IRS Topic No. 558; 26 U.S.C. 72(t)). Vested balances can be rolled over to an IRA.
