What is Profit Sharing?

profit sharing plansProfit sharing is a benefit offered by businesses to help instill a sense of ownership in their employees. People motivated by money may work harder knowing that the more profitable their business, the greater their profit sharing allocation will be. Some business owners feel profit sharing creates a sense of teamwork and increases the efficiency of the workforce as employees have the same goal: generate profits.

A business first determines the percentage of profits they are willing to share and then decides how to spread the funds out between employees. Frequently, profit sharing will be paid out based on a predetermined percent of an employee’s annual salary (4% of gross pay, for example), but there are other options. Profit sharing can also be distributed as a flat dollar amount of profit sharing paid out for each dollar earned. By using these two methods, higher paid employees will received a greater amount of the profit.

To equalize the workplace, some businesses divide the pool of profit-sharing money equally. For example, if $10,000 has been set aside by a business for profit sharing and there are five employees, each is given $2,000 as their part of the profit sharing.

Businesses can decide how much of the profits are shared, and the percentage or method can change annually. In bad years, the business can choose not to fund a profit-sharing plan. Limits can be placed on how much profit sharing is disbursed to employees.

The plan can be managed in-house or by a third party, but it must be in writing. An account must be created to hold the profit-sharing funds, and recordkeeping must be maintained in compliance with state and federal regulations.

Profit-sharing payments are usually made on an annual basis only after the business has completed the year-end reports and profits have been determined. There may be restrictions placed on employee access to the funds, such as mandating a specific time period of employment before funds can be withdrawn. If the restrictions are ignored, penalties can be assessed or money accumulated in the fund may be forfeited.

Although cash is a common method used for profit sharing, businesses can also provide stocks, mutual funds, or bonds.

For more information on profit sharing accounts, refer to the U.S. Dept. of Labor website

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