Similar to a SEP, a profit sharing plan offers the flexibility of making contributions -- up to 15 percent of compensation paid to all employees, but no more than $30,000 for any one individual. Alternatively, rather than selecting a percentage, a flat amount (for example, $100,000) could be allocated among eligible employees. Contributions are keyed to the existence of profits, although they may be possible even if the company suffers a loss in the taxable year.
Profit sharing plans differ from SEPs in several distinct ways. An employer can apply a vesting schedule to the company's contributions, based on an employee's length of service with the company. If an employee is terminated before becoming fully vested, his or her funds will revert to the plan or be reallocated among the remaining participants. In addition, profit sharing plans permit the exclusion of part-time employees and can be used for loan purposes.
Profit sharing plans, as all other qualified retirement plans, require the preparation of formal trust documents as well as annual tax filings. A standardized trust or prototype plan will often satisfy requirements and will typically be less expensive and simpler to operate than an individually designed plan.
