When it comes to profit sharing, business owners ultimately control who is eligible to participate, and who is not. However, the decision can’t, and shouldn’t, be made haphazardly. There are many things to consider as you answer this question, including the type of program to set up – funded, qualified profit sharing(which is the traditional model) or unfunded, non-qualified profit sharing.We’ll first explore the traditional model where any exclusions from a profit-sharing program must have logical justification and conform to IRS requirements.
Reasonable Exclusions
Profit sharing is intended to be a benefit that includes a mix non-managerial employees and owners/managers. And in most cases, it is open to all who work for the business. But there are exceptions that can be made, though any exception should be checked against government regulations:
- Job classification: In certain cases, employees under specific job classifications may be excluded from the plan. For example, an employer might want to exclude high compensation employees (HCE). You must set a clear threshold for an employee to qualify as an HCE before excluding them. And this provision of the program can be amended over time.
- Contributions towards success: Some roles within a company contribute more than others towards its profits. A business can target the program to only those essential to making money.
- Employment tenure: Profit sharing kicks in after one year of employment, in most cases. For certain plans, the qualifying tenure can be set at two years.
- Age limit: Participants must be 21 years old or older to receive this benefit.
- Residency: Business owners can specify location and residency requirements to receive profit sharing benefits.
- Collective bargaining agreement: Employees who are covered by labor agreements under a collective bargaining agreement may be ineligible to participate.
Why Include Every Employee
While it might seem to spread the pool for profit sharing a little thinly, there are many good reasons to include all legally eligible employees in your plan.
- Participating employees experience increased motivation to do a good job. This results in improved productivity and even more profits.
- Being more productive and seeing actual returns on their work encourages more employee engagement, improves team morale and enhances job satisfaction.
- Offer ingthis benefit to all job candidates helps attract talent. Plus, seasoned employees are incentivized to stick around.
- From a business standpoint, you’re allowed to deduct profit-sharing contributions from your taxes as an expense.
Why Exclude Some Employees
Although most plans err on the side of including everyone in the program, there are legitimate reasons a business chooses to exclude some employees from profit sharing.
- Legal and practical reasons: If your plan falls under any of the above exclusions, you should set it up accordingly.
- Contribution inequality: Evenly sharing business profits among those whose work directly affects income and hose who aren’t in revenue-generating roles could foster resentment among theteam. Including everyone in the program risks alienating those high performers,which could lead to resentment and lessened productivity.
- Sustainability: Including more employees in profit sharing means more revenue needs to be allocated. Maintaining the burden of expected returns can be difficult over time, which may risk the business’ financial security.
What’s Different for Unfunded, Nonqualified Profit Sharing
If the above sounds like a lot of rules and regulations and you’re looking for an alternative, you should consider the unfunded, non-qualified option. This typeof program, which is what we support at Reins, can be an easier option for small to medium sized businesses because of their flexibility andcost-effectiveness. In this chart you’ll find some key feature comparisons.
But no matter how you choose to set up profit-sharing beneficiaries you must have a written plan document that contains all of the details. And there should be a strategy to clearly communicate the details to the company’s employees.
Transparency is key, so those include and those excluded understand the why behind your decision. Communicating regularly about the health of the program, the participants and any administrative change helps maintain a healthy working environment and productive team.
Because even an unfunded, non-qualified profit-sharing program can be a bear to administer, Reins offers MARE Profit. This is a proprietary plan designed to meet the needs of small and mid-sized private businesses, who need assistance in making short-term cash distributions to their employees.
