A profit sharing plan is a defined contribution retirement plan that accepts discretionary employer contributions, meaning the employer decides each year whether to contribute and how much, with the money placed in a separate account for each employee (Source: IRS, “Choosing a retirement plan: Profit sharing plan”). The total that can land in any one participant’s account for 2026 is capped at $72,000 (Source: IRS Notice 2025-67).
A profit sharing plan lets an employer make flexible, discretionary contributions to employees’ retirement accounts. For 2026, total annual additions to one participant’s account are limited to $72,000 under Internal Revenue Code section 415(c), and the employer’s deduction is separately capped at 25% of eligible compensation (Source: IRS Notice 2025-67; IRS Publication 560).
What a profit sharing plan is
A profit sharing plan is a type of defined contribution plan in which an employer makes discretionary contributions to a separate account for each eligible employee. The contributions are optional year to year, so an employer can contribute in profitable years and skip contributions in lean ones (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
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Despite the name, contributions do not have to come from actual profits. The Internal Revenue Service allows a business to make profit sharing contributions regardless of whether the company recorded a profit, so the term describes the plan structure rather than a funding requirement (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
The plan holds employer money only in its pure form. If a business adds a salary deferral feature that lets employees contribute their own pay, the IRS classifies the arrangement as a 401(k) plan (Source: IRS, “Choosing a retirement plan: Profit sharing plan”). This is why many employer plans are described as combined 401(k) profit sharing plans.
How profit sharing plan contributions work in 2026
Contributions to a profit sharing plan are set by the employer each year and allocated to individual participant accounts using a written formula in the plan document. For 2026, the total of all annual additions to a single participant’s account cannot exceed $72,000, the section 415(c) limit (Source: IRS Notice 2025-67).
Section 415(c) caps annual additions at the lesser of the dollar limit or 100% of the participant’s compensation for the year (Source: 26 U.S.C. 415(c)(1)). Annual additions include employer contributions, any employee elective deferrals, and reallocated forfeitures from participants who left before vesting (Source: IRS Publication 560, 2025).
Two separate limits apply at the same time and can be confused. The $72,000 figure is a per-participant annual additions cap. A distinct rule under section 404 limits the employer’s tax deduction to 25% of the compensation paid to eligible participants, discussed in the next section (Source: IRS Publication 560, 2025). The compensation counted per participant is itself capped at $360,000 for 2026 under section 401(a)(17) (Source: IRS Notice 2025-67).
2026 figures relevant to a profit sharing plan
The dollar limits that shape profit sharing plan design changed for 2026 under IRS Notice 2025-67. The table below lists the figures most often used when calculating employer contributions and deductions. Q3 Advisors summarizes the full annual set on its 2026 retirement contribution limits page.
| Limit (2026) | Amount | Code section |
|---|---|---|
| Annual additions per participant | $72,000 | 415(c) |
| Employer deduction cap | 25% of eligible compensation | 404 |
| Compensation counted per participant | $360,000 | 401(a)(17) |
| 401(k) elective deferral | $24,500 | 402(g) |
| Age 50 catch-up (401(k)) | $8,000 | 414(v) |
| Ages 60-63 enhanced catch-up | $11,250 | 414(v)(2)(E) |
| 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.
The 25% employer deduction limit versus the $72,000 limit
The 25% deduction limit and the $72,000 annual additions limit are two different rules that both apply to a profit sharing plan, and they are easy to confuse. The 25% cap under section 404 limits how much the employer can deduct on its tax return; the $72,000 cap under section 415(c) limits how much can be added to any one participant’s account (Source: IRS Publication 560, 2025; IRS Notice 2025-67).
Under section 404, the employer’s deduction for contributions to a profit sharing or other defined contribution plan is limited to 25% of the compensation paid or accrued during the year to eligible participants (Source: IRS Publication 560, 2025). Publication 560 states the deduction limit as 25% of all participants’ compensation, plus the amount of elective deferrals made.
Employee elective deferrals in a combined 401(k) profit sharing plan do not count against the 25% employer deduction limit (Source: IRS Publication 560, 2025). Contributions that exceed the 25% deduction limit are generally not lost; the excess can carry over and be deducted in later years, subject to the same annual limit (Source: IRS Publication 560, 2025).
A short example shows how the two limits interact. If an employee earns $200,000 in 2026, the 25% figure applied to that salary is $50,000, which is below the $72,000 annual additions ceiling, so the deduction limit is the binding constraint for that person. For a highly paid participant, the $72,000 section 415(c) cap can bind first. Individual results depend on the plan’s formula and each participant’s compensation.
Profit sharing allocation formulas
An allocation formula is the written method a profit sharing plan uses to divide the employer’s total contribution among participant accounts. A profit sharing plan must provide a definite predetermined formula for allocating contributions among participants (Source: 26 CFR 1.401-1(b)(1)(ii)). In practice, common designs include pro-rata, integrated (permitted disparity), age-weighted, and new comparability (also called cross-tested) approaches.
| 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 |
| 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 as to contributions or benefits (Source: 26 U.S.C. 401(a)(4)). Separately, a plan that is top-heavy, meaning key employees hold more than 60% of plan assets, must generally provide a minimum contribution for non-key employees (Source: 26 U.S.C. 416; IRS Notice 2025-67 sets the 2026 key employee threshold at $235,000). Whether a given formula suits a business depends on its workforce and goals, and plan design questions are typically reviewed with a qualified professional.
Profit sharing plan versus 401(k)
A profit sharing plan holds only discretionary employer contributions, while a 401(k) plan adds a salary deferral feature that lets employees contribute their own pay. When a profit sharing plan includes that deferral feature, the IRS treats it as a 401(k) plan, and many employers run the two together as a single combined plan (Source: IRS, “Choosing a retirement plan: Profit sharing 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 (Source: IRS Notice 2025-67) |
| 2026 annual additions cap per participant | $72,000 (Source: IRS Notice 2025-67) | $72,000 (Source: IRS Notice 2025-67) |
| Contribution flexibility | Employer can vary or skip year to year | Employees choose deferral rate; employer match may be fixed |
The two 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 employee 401(k) deferrals is one approach employers use to direct more into a participant’s account within that single cap.
How distributions and taxes generally work
Money in a traditional profit sharing plan grows tax-deferred, and distributions are generally taxed as ordinary income when taken (Source: IRS Publication 575, “Pension and Annuity Income”). 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 specific tax result depends on the account type and the participant’s circumstances.
Large pre-tax retirement balances can raise taxable income in retirement, which may affect related items such as Medicare premiums and the taxation of Social Security. Readers weighing those interactions can review Q3 Advisors research on Medicare IRMAA 2026 brackets, the Social Security tax torpedo, and required minimum distributions for 2026.
Some savers evaluate whether converting pre-tax balances to Roth accounts fits their situation, a strategy that can change the timing of tax. Q3 Advisors offers a Roth conversion service that addresses these questions. 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 article is educational and is not advice; for guidance on your own circumstances, consult a qualified tax or financial professional.
Frequently asked questions
The questions below cover the points people most often raise about profit sharing plans, including the 2026 contribution and deduction limits, how these plans differ from a 401(k), whether contributions must come from profits, and how withdrawals are taxed. Each answer cites a primary IRS source, and figures reflect published amounts for the year stated.
What is a profit sharing plan?
A profit sharing plan is a defined contribution retirement plan that accepts discretionary employer contributions, with money placed in a separate account for each employee. The employer decides each year whether to contribute and how much, and contributions do not have to come from company profits (Source: IRS, “Choosing a retirement plan: Profit sharing plan”).
How much can an employer contribute to a profit sharing plan in 2026?
For 2026, total annual additions to one participant’s profit sharing account are limited to $72,000 under section 415(c), or 100% of that person’s compensation if lower (Source: IRS Notice 2025-67; 26 U.S.C. 415(c)). Separately, the employer’s deduction is capped at 25% of eligible compensation under section 404 (Source: IRS Publication 560, 2025).
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. 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, “Choosing a retirement plan: Profit sharing plan”).
What is the 25% rule for profit sharing plans?
The 25% rule is the employer deduction limit under section 404. An employer can generally deduct profit sharing contributions up to 25% of the compensation paid to eligible participants for the year, and employee elective deferrals do not count toward that limit (Source: IRS Publication 560, 2025). It is separate from the $72,000 annual additions cap.
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 limits.
How are profit sharing plan withdrawals 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.
Sources
IRS Notice 2025-67, “2026 Amounts Relating to Retirement Plans and IRAs,” https://www.irs.gov/pub/irs-drop/n-25-67.pdf (also Internal Revenue Bulletin 2025-49).
IRS Publication 560 (2025), “Retirement Plans for Small Business,” https://www.irs.gov/publications/p560.
IRS, “Choosing a retirement plan: Profit sharing plan,” https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-profit-sharing-plan.
26 U.S.C. 415, https://www.law.cornell.edu/uscode/text/26/415.
26 U.S.C. 401(a)(4), https://www.law.cornell.edu/uscode/text/26/401.
26 U.S.C. 416, “Special rules for top-heavy plans,” https://www.law.cornell.edu/uscode/text/26/416.
26 U.S.C. 72(t), “10-percent additional tax on early distributions,” https://www.law.cornell.edu/uscode/text/26/72.
26 CFR 1.401-1(b)(1)(ii) (definite predetermined allocation formula), https://www.law.cornell.edu/cfr/text/26/1.401-1.
IRS Topic No. 558, “Additional tax on early distributions from retirement plans other than IRAs,” https://www.irs.gov/taxtopics/tc558.
IRS Publication 575, “Pension and Annuity Income,” https://www.irs.gov/publications/p575.
IRS, “401(k) limit increases to $24,500 for 2026,” https://www.irs.gov/newsroom/401k-limit-increases-to-24500-for-2026-ira-limit-increases-to-7500.
