–1–

PROFIT 

SHARING PLANS for Small 

Businesses
Profi t Sharing Plans for Small Businesses is a joint project of the U.S. Department of Labor’s 

Employee Benefi ts Security Administration (EBSA) and the Internal Revenue Service (IRS). Its 

publication does not constitute legal, accounting, or other professional advice.

This publication and other EBSA materials are available by calling toll-free: 

866-444-EBSA (3272)

Or visit the agency’s Web site at: www.dol.gov/ebsa

Profi t Sharing Plans for Small Businesses (IRS Publication 4806) is also available 

from the IRS at: 

800-TAX-FORM (800-829-3676)

(Please indicate catalog number 53787K when ordering) 

This material is available to sensory impaired individuals upon request: 

Voice phone: 202-693-8664

TDD: 202-501-3911

 This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
–1–

WHY PROFIT SHARING PLANS?

Profi t sharing plans can be a powerful tool in 

promoting fi nancial security in retirement. They 

are a valuable option for businesses considering 

a retirement plan, providing benefi ts to 

employees and their employers.

Employers start a profi t sharing plan for a host of 

reasons:

❑ A well-designed profi t sharing plan can help 

attract and keep talented employees.

❑ Contributions to a profi t sharing plan are 

discretionary. The employer can choose 

when and how much to contribute.

❑ This type of plan gives employers fl exibility 

in design of key features.

❑ A profi t sharing plan benefi ts a mix of rankand-fi le employees and owner/managers.

❑ The money contributed may grow through 

investments in stocks, mutual funds and other 

investment vehicles.

❑ Contributions and earnings generally are not 

taxed by the Federal government or by State 

governments until they are distributed.

❑ A profi t sharing plan may allow participants 

to take their benefi ts with them when they 

leave the company, easing administrative 

responsibilities.

This booklet highlights some of a profi t sharing 

plan’s advantages and some of your options 

and responsibilities as an employer operating 

a profi t sharing plan. For more information, a 

list of resources for you and for prospective 

plan participants is included at the end of this 

booklet.

ESTABLISHING A PROFIT 

SHARING PLAN

When you establish a profi t sharing plan, you 

must take certain basic actions. One of your 

fi rst decisions will be whether to set up the 

plan yourself or to consult a professional or 

fi nancial institution — such as a bank, mutual 

fund provider, or insurance company — for help 

with establishing and maintaining the plan. In 

addition, there are four initial steps for setting up 

a profi t sharing plan:

❑ Adopt a written plan document,

❑ Arrange a trust fund for the plan’s assets,

❑ Develop a recordkeeping system, and

❑ Provide plan information to participants.

Adopt a written plan document — Plans 

begin with a written document that serves as the 

foundation for day-to-day plan operations. If 

you have hired someone to help with your plan, 

that person likely will provide it. If not, consider 

obtaining assistance from a fi nancial institution or 

retirement plan professional. In either case, you 

will be bound by the terms of the plan document.

A profi t sharing plan allows you to decide 

(within limits) from year to year whether 

to contribute on behalf of participants. If 

you do make contributions, you will need 

to have a set formula for determining how 

the contributions are divided. This money is 

accounted for separately for each employee. 

Your contributions to the plan can be subject 

to a vesting schedule (which provides that an 

employee’s right to employer contributions 

becomes nonforfeitable only after a period of 

time). Annual testing ensures that benefi ts for 

rank-and-fi le employees are proportional to 

benefi ts for owners/managers. 

Once you have decided on a profi t sharing plan 

for your company, you will have fl exibility in 

choosing some of the plan’s features — such as 

when and which employees can participate in 

the plan. Other features written into the plan are 
–2–

required by law. For instance, the plan document 

must describe how certain key functions are 

carried out, such as how contributions are 

deposited in the plan. 

Unless it includes a 401(k) cash or deferred 

feature, a profi t sharing plan does not usually 

allow employees to contribute. If you want to 

include employee contributions, see 401(k) 

Plans for Small Businesses (Publication 4222).

A profi t sharing plan can be for employers of 

any size.

Arrange a trust fund for the plan’s assets — 

A plan’s assets must be held in trust to assure that 

assets are used solely to benefi t the participants 

and their benefi ciaries. The trust must have at 

least one trustee to handle contributions, plan 

investments, and distributions. Since the fi nancial 

integrity of the plan depends on the trustee, 

selecting a trustee is one of the most important 

decisions you will make in establishing a profi t 

sharing plan. If you set up your plan through 

insurance contracts, the contracts do not need to 

be held in trust.

Develop a recordkeeping system — An 

accurate recordkeeping system will track and 

properly attribute contributions, earnings and 

losses, plan investments, expenses, and benefi t 

distributions. If a contract administrator or 

fi nancial institution assists in managing the plan, 

that entity typically will help keep the required 

records. In addition, a recordkeeping system will 

help you, your plan administrator, or fi nancial 

provider prepare the plan’s annual return/report 

that must be fi led with the Federal government.

Provide plan information to participants — 

You must notify employees who are participants 

in the plan about certain benefi ts, rights, and 

features. In addition, a summary plan description 

(SPD) must be provided to all participants. The 

SPD is the primary vehicle to inform participants 

and benefi ciaries about the plan and how it 

operates. The SPD typically is created with the 

plan document. (For more information on the 

required contents of the SPD, see Disclosing 

Plan Information to Participants.)

OPERATING A PROFIT

SHARING PLAN

Once you have established a profi t sharing 

plan, you assume certain responsibilities in 

operating the plan. If you hired someone to 

help in setting up your plan, that arrangement 

also may have included help in operating the 

plan. If not, another important decision will be 

whether to manage the plan yourself or to hire 

a professional or fi nancial institution — such 

as a bank, mutual fund provider, or insurance 

company — to take care of some or most 

aspects of operating the plan. 

Elements of operating profi t sharing plans 

include the following:

❑ Participation

❑ Contributions

❑ Vesting

❑ Nondiscrimination

❑ Investing profi t sharing plan monies

❑ Fiduciary responsibilities

❑ Disclosing plan information to participants

❑ Reporting to government agencies

❑ Distributing plan benefi ts

Participation

Typically, a plan includes a mix of rank-andfi le employees and owner/managers. However, 

some employees may be excluded from a profi t 

sharing plan if they:

❑ Have not attained age 21;

❑ Have not completed a year of service (2 years 

in certain plans); or

❑ Are covered by a collective bargaining 

agreement that does not provide for 

participation in the plan, if retirement benefi ts 

were the subject of good faith bargaining. 
–3–

Employees cannot be excluded from a plan 

merely because they are older workers.

Contributions

In a profi t sharing plan, you can decide on your 

business’s contribution (if any) to participants’ 

accounts in the plan. You have the fl exibility of 

changing the amount you contribute to the plan 

each year, according to business conditions.

If you do make contributions, you will need 

to have a set formula for determining how 

the contributions are allocated to participants’ 

accounts. The simplest, and most common, 

allocation formula specifi es that the employer 

contribution is allocated so that each participant 

receives an amount that is the same percentage 

of his or her compensation. 

Contribution Limits

Employer contributions and forfeitures 

(nonvested employer contributions of terminated 

participants) are subject to a per-employee overall 

annual limitation. This limit is the lesser of:

❑ 100 percent of the employee’s compensation, 

or

❑ $49,000 per year for 2009 and 2010.

Employers can deduct amounts that do not 

exceed 25 percent of aggregate compensation 

for all participants and the per-employee limits 

mentioned above.

Vesting

In profi t sharing plans, you can design your plan 

so that employer contributions become vested 

(nonforfeitable) over time, according to a vesting 

schedule. 

If you require 2 years of service to participate, 

all contributions are immediately vested. All 

employees must be vested according to plan 

terms.

Nondiscrimination

In order to preserve the tax benefi ts of a profi t 

sharing plan, the plan must provide substantive 

benefi ts for rank-and-fi le employees, not 

just business owners and managers. These 

requirements are called nondiscrimination 

rules and compare both plan participation and 

contributions of rank-and-fi le employees to 

owners/managers.

Traditional profi t sharing plans are subject to 

annual testing to assure that the amount of 

contributions does not discriminate in favor of 

owners and managers. If you allocate a uniform 

percentage of compensation to each participant, 

then no testing is required because your plan 

automatically satisfi es the nondiscrimination 

requirement. 

Investing Profi t Sharing Plan Monies

After you decide on a profi t sharing plan, you 

can consider the variety of investment options. 

One decision you will need to make in designing 

a plan is whether to permit your employees 

to direct the investment of their accounts or 

to manage the monies on their behalf. If you 

choose the former, you also need to decide what 

investment options to make available to the 

participants. Depending on the plan design you 

choose, you may want to hire someone either 

to determine the investment options to make 

available or to manage the plan’s investments. 

Continually monitoring the investment options 

ensures that your selections remain in the best 

interests of your plan and its participants.

Fiduciary Responsibilities

Many of the actions needed to operate a profi t 

sharing plan involve fi duciary decisions. This 

is true whether you hire someone to manage 

the plan for you or do some or all of the plan 

management yourself. Controlling the assets of 

the plan or using discretion in administering 

and managing the plan makes you or the entity 

you hire a plan fi duciary to the extent of that 

discretion or control. Thus, fi duciary status is 
–4–

based on the functions performed for the plan, 

not a title. Be aware that hiring someone to 

perform fi duciary functions is itself a fi duciary act. 

Some decisions with respect to a plan are 

business decisions, rather than fi duciary 

decisions. For instance, the decisions to 

establish a plan, to include certain features 

in a plan, to amend a plan, and to terminate 

a plan are business decisions. When making 

these decisions, you are acting on behalf of 

your business, not the plan, and therefore, you 

would not be a fi duciary. However, when you 

take steps to implement these decisions, you (or 

those you hire) are acting on behalf of the plan 

and thus, in making decisions, may be acting as 

fi duciaries.

Basic Responsibilities

Those persons or entities that are fi duciaries 

are in a position of trust with respect to the 

participants and benefi ciaries in the plan. The 

fi duciary’s responsibilities include:

❑ Acting solely in the interest of the participants 

and their benefi ciaries;

❑ Acting for the exclusive purpose of providing 

benefi ts to workers participating in the 

plan and their benefi ciaries, and defraying 

reasonable expenses of the plan;

❑ Carrying out duties with the care, skill, 

prudence, and diligence of a prudent person 

familiar with such matters;

❑ Following the plan documents; 

❑ Diversifying plan investments.

These are the responsibilities that fi duciaries 

need to keep in mind as they carry out their 

duties. The responsibility to be prudent covers 

a wide range of functions needed to operate 

a plan. And, since all these functions must be 

carried out in the same manner as a prudent 

person would, it may be in your best interest 

to consult experts in various fi elds, such as 

investments and accounting.

The plan must designate a fi duciary, typically 

the trustee, to make sure that contributions due 

to the plan are collected. If the plan and other 

documents are silent or ambiguous, the trustee 

generally has this responsibility. As part of 

following the plan documents in operating your 

plan, the plan document will need to be updated 

from time to time for changes in the law.

Limiting Liability

With these responsibilities, there is also some 

potential liability. However, there are actions 

you can take to demonstrate that you carried out 

your responsibilities properly as well as ways to 

limit your liability.

The fi duciary responsibilities cover the process 

used to carry out the plan functions rather than 

simply the end results. For example, if you 

or someone you hire makes the investment 

decisions for the plan, an investment does 

not have to be a “winner” if it was part of a 

prudent overall diversifi ed investment portfolio 

for the plan. Since a fi duciary needs to carry 

out activities through a prudent process, you 

should document the decision-making process to 

demonstrate the rationale behind the decision at 

the time it was made.

In addition to the steps above, there are other 

ways to limit potential liability. The plan can 

be set up to give participants control of the 

investments in their accounts. For participants 

to have control, they must have suffi cient 

information on the specifi cs of their investment 

options. If properly executed, this type of plan 

limits your liability for the investment decisions 

made by participants. You can also hire a service 

provider or providers to handle some or most of 

the fi duciary functions, setting up the agreement 

so that the person or entity then assumes 

liability.

Hiring a Service Provider

Even if you do hire a fi nancial institution 

or retirement plan professional to manage 
–5–

the whole plan, you retain some fi duciary 

responsibility for the decision to select and 

keep that person or entity as the plan’s service 

provider. Thus, you should document your 

selection process and monitor the services 

provided to determine if a change needs to be 

made.

Some items to consider in selecting a plan 

service provider:

❑ Information about the fi rm itself: affi liations, 

fi nancial condition, experience with profi t 

sharing plans, and assets under their control;

❑ A description of business practices: how 

plan assets will be invested if the fi rm will 

manage plan investments or how participant 

investment directions will be handled, and 

proposed fee structure; 

❑ Information about the quality of prospective 

providers: the identity, experience, and 

qualifi cations of the professionals who will 

be handling the plan’s account; any recent 

litigation or enforcement action that has been 

taken against the fi rm; the fi rm’s experience 

or performance record; if the fi rm plans to 

work with any of its affi liates in handling 

the plan’s account; and whether the fi rm has 

fi duciary liability insurance. 

Once hired, these are additional actions to take 

when monitoring a service provider:

❑ Review the service provider’s performance;

❑ Read any reports they provide;

❑ Check actual fees charged;

❑ Ask about policies and practices (such as 

trading, investment turnover, and proxy 

voting); and

❑ Follow up on participant complaints.

(For more information, see Understanding 

Retirement Plan Fees and Expenses at 

www.dol.gov/ebsa.) 

Prohibited Transactions and Exemptions

There are certain transactions that are prohibited 

under the law to prevent dealings with parties 

that have certain connections to the plan, 

self-dealing, or confl icts of interest that could 

harm the plan. However, there are a number 

of exceptions under the law, and additional 

exemptions may be granted by the U.S. 

Department of Labor, where protections for the 

plan are in place in conducting the transactions.

One exemption allows the provision of 

investment advice to participants who direct the 

investments in their accounts. This applies to 

the buying, selling, or holding of an investment 

related to the advice as well as to the receipt 

of related fees and other compensation by a 

fi duciary adviser. Please check www.dol.gov/

ebsa for more information.

Another exemption in the law permits you to 

offer loans to participants through your plan. 

If you do, the loan program must be carried 

out in such a way that the plan and all other 

participants are protected. Thus, the decision 

with respect to each loan request is treated as a 

plan investment and considered accordingly. 

Bonding

Persons handling plan funds or other plan 

property generally must be covered by a fi delity 

bond to protect the plan against loss resulting 

from fraud and dishonesty by those covered by 

the bond.

Disclosing Plan Information to Participants

Plan disclosure documents keep participants 

informed about the basics of plan operation, 

alert them to changes in the plan’s structure and 

operations, and provide them a chance to make 

decisions and take timely action with respect to 

their accounts.

The summary plan description (SPD) — 

the basic descriptive document — is a plainlanguage explanation of the plan and must be 
–6–

comprehensive enough to apprise participants of 

their rights and responsibilities under the plan. It 

also informs participants about the plan features 

and what to expect of the plan. Among other 

things, the SPD must include information about:

❑ When and how employees become eligible to 

participate in the profi t sharing plan;

❑ The contributions to the plan;

❑ How long it takes to become vested;

❑ When employees are eligible to receive their 

benefi ts;

❑ How to fi le a claim for those benefi ts; and

❑ Basic rights and responsibilities participants 

have under the Federal retirement law, the 

Employee Retirement Income Security Act 

(ERISA).

The SPD should include an explanation about 

the administrative expenses that will be paid 

by the plan. This document must be given to 

participants when they join the plan and to 

benefi ciaries when they fi rst receive benefi ts. 

SPDs must also be redistributed periodically 

during the life of the plan.

A summary of material modifi cation (SMM)

apprises participants of changes made to the 

plan or to the information required to be in 

the SPD. The SMM or an updated SPD must be 

automatically furnished to participants within a 

specifi ed number of days after the change.

An individual benefi t statement (IBS) shows 

the total plan benefi ts earned by a participant, 

vested benefi ts, the value of each investment 

in the account, information describing the 

ability to direct investments, and (for plans 

with participant direction) an explanation of 

the importance of a diversifi ed portfolio. Plans 

that provide for participant-directed accounts 

must furnish individual benefi t statements on a 

quarterly basis. Plans that do not provide for 

participant direction must furnish statements 

annually. 

A summary annual report (SAR) is a narrative 

of the plan’s annual return/report, the Form 

5500, fi led with the Federal government (see 

Reporting to Government Agencies for more 

information). It must be furnished annually to 

participants.

A blackout period notice gives employees 

advance notice when a blackout period occurs, 

typically when plans change recordkeepers 

or investment options, or when plans add 

participants due to corporate mergers or 

acquisitions. During a blackout period, 

participants’ rights to direct investments, take 

loans, or obtain distributions are suspended.

Reporting to Government Agencies

In addition to the disclosure documents that 

provide information to participants, plans must 

also report certain information to government 

entities.

Form 5500, Annual Return/Report of Employee 

Benefi t Plans

Plans are required to fi le an annual return/

report with the Federal government, in which 

information about the plan and its operation is 

disclosed to the IRS and the U.S. Department 

of Labor. Beginning with the reports for 2009, 

plans that must fi le the Form 5500 must do so 

electronically. These reports are made available 

to the public. 

Depending on the number and type of 

participants covered, most profi t sharing plans 

must fi le one of the following forms:

❑ Form 5500, Annual Return/Report of 

Employee Benefi t Plan, 

❑ Form 5500-SF, Short Form Annual Return/

Report of Small Employee Benefi t Plan 

(available January 1, 2010), or

❑ Form 5500-EZ, Annual Return of OneParticipant (Owners and Their Spouses) 

Retirement Plan
–7–

Most one-participant plans (sole proprietor and 

partnership plans) with total assets of $250,000 

or less are exempt from the annual fi ling 

requirement. However, regardless of the value 

of the plan’s assets, a fi nal return/report must be 

fi led when a plan is terminated.

Form 1099-R

Form 1099-R, Distributions From Pensions, 

Annuities, Retirement or Profi t Sharing Plans, 

IRAs, Insurance Contracts, etc. is given to 

both the IRS and recipients of distributions 

from the plan during the year. It is used to 

report distributions (including rollovers) from a 

retirement plan.

Distributing Plan Benefi ts

Benefi ts in a profi t sharing plan are dependent 

on a participant’s account balance at the time of 

distribution.

When participants are eligible to receive a 

distribution, they typically can elect to:

❑ Take a lump sum distribution of their account,

❑ Have their account transferred directly to an 

IRA or another employer’s retirement plan, or

❑ Take periodic distributions.

TERMINATING A PROFIT 

SHARING PLAN

Profi t sharing plans must be established with 

the intention of being continued indefi nitely. 

However, business needs may require that 

employers terminate their profi t sharing plans. 

For example, you may want to establish another 

type of retirement plan in lieu of the profi t 

sharing plan.

Typically, the process of terminating a profi t 

sharing plan includes amending the plan 

document, distributing all assets, and fi ling a 

fi nal Form 5500. You must also notify your 

employees that the plan will be discontinued. 

Check with your plan’s fi nancial institution or a 

retirement plan professional to see what further 

action is necessary to terminate your profi t 

sharing plan.

COMPLIANCE

Even with the best intentions, mistakes in plan 

operation can still happen. The U.S. Department 

of Labor and IRS have correction programs to 

help profi t sharing plan sponsors correct plan 

errors, protect participants, and keep the plan’s 

tax benefi ts. These programs are structured to 

encourage early correction of the errors. Having 

an ongoing review program makes it easier to 

spot and correct mistakes in plan operations. See 

the Resources section for further information.

A PROFIT SHARING PLAN 

CHECKLIST

1. Have you decided how much to contribute 

 to the plan this year? 

 2. Have you decided to hire a fi nancial 

 institution or retirement plan professional 

 to help with setting up and running the 

 plan?

 3. Have you adopted a written plan that 

 includes the features you want to offer, 

 such as how contributions will be allocated 

 and when they will be vested?

 4. Have you notifi ed participants and 

 provided them with information to help in 

 their decision making?

 5. Have you arranged a trust fund for the 

 plan assets or will you set up the plan solely 

 with insurance contracts?

6. Have you developed a recordkeeping 

 system?

7. Are you familiar with the fi duciary 

 responsibilities?

 8. Are you prepared to monitor the plan’s 

 service providers?

 9. Are you familiar with the reporting and 

 disclosure requirements of a profi t sharing 

 plan?

For help in establishing and operating a profi t sharing plan, 

you may want to talk to a retirement plan professional or a 

representative of a fi nancial institution that offers retirement 

plans —and take advantage of the help available in the 

following Resources section.
–8–

RESOURCES

To Find Out More...

Expanded information on the topics addressed in 

this publication is available on the IRS and U.S. 

Department of Labor’s (DOL’s) Employee Benefi ts 

Security Administration’s Web sites, www.irs.

gov/ep and www.dol.gov/ebsa. For the IRS, 

go to the IRS Web address and click on “Types of 

Plans” in the left pane. For DOL, go to the DOL 

Web address and click on “Publications/Reports” 

and scroll down to “Compliance Assistance 

Publications – Retirement.”

The Web sites feature this publication as well as 

additional information on profi t sharing plans 

and other retirement plans, as listed below. 

Publications can be ordered by calling the 

appropriate agency’s toll-free number — for the 

IRS, (800) TAX-FORM (829-3676) or for DOL, 

(866) 444-EBSA (3272).

The following items, issued by both the IRS and 

DOL, are available on the Web and through the 

toll-free numbers:

Choosing a Retirement Solution for Your Small 

Business, Publication 3998, provides an overview 

of retirement plans available to small businesses.

401(k) Plans for Small Businesses, Publication 

4222, provides detailed information regarding the 

establishment and operation of a 401(k) plan.

Automatic Enrollment 401(k) Plans for Small 

Businesses, Publication 4674, explains a type of 

retirement plan that allows small businesses to 

increase plan participation. 

Payroll Deduction IRAs for Small Businesses, 

Publication 4587, describes an arrangement that 

is an easy way for businesses to give employees 

an opportunity to save for retirement.

Retirement Plan Correction Programs, Publication 

4224, provides a brief description of the IRS and 

DOL correction programs. The publication also 

includes a description of programs sponsored 

by the Pension Benefi t Guaranty Corporation 

(PBGC) that apply to defi ned benefi t plans.

SEP Retirement Plans for Small Businesses, 

Publication 4333, provides a brief description of 

this low-cost type of retirement plan.

SIMPLE IRA Plans for Small Businesses, 

Publication 4334, describes a simple way for 

small businesses to contribute toward retirement. 

Related materials available from DOL:

For small businesses:

Understanding Retirement Plan Fees and Expenses

Meeting Your Fiduciary Responsibilities

Selecting an Auditor for Your Employee Benefi t 

Plan

Reporting and Disclosure Guide for Employee 

Benefi t Plans

To view these publications, go to www.dol.gov/

ebsa and click on “Publications and Reports.”

In addition, DOL sponsors two interactive Web 

sites — the Small Business Advisor, available 

at www.dol.gov/elaws/pwbaplan.htm, and, 

along with the American Institute of Certifi ed 

Public Accountants (AICPA), 

www.choosingaretirementsolution.org.

For employees:

A Look at 401(k) Plan Fees

What You Should Know about Your Retirement 

Plan (also in Spanish)

Savings Fitness...A Guide To Your Money and 

Your Financial Future (also in Spanish)

Taking the Mystery Out of Retirement Planning 

(also in Spanish)
–9–

Top 10 Ways to Prepare for Retirement (also in 

Spanish)

Women and Retirement Savings (also in Spanish)

To view these publications, go to www.dol.gov/

ebsa and click on “Publications and Reports.”

Related materials available from the IRS:

The Retirement Plans Products Navigator,

Publication 4460.

Lots of Benefi ts, Publication 4118, discusses the 

benefi ts of sponsoring a retirement plan and the 

stages involved in the life cycle of a retirement 

plan.

Have You Had Your Check-up This Year for 

401(k) Retirement Plans, Publication 3066, 

encourages employers to perform a periodic 

“check-up” of their 401(k) retirement plans 

through the use of a checklist, and how to 

initiate corrective action if necessary.

401(k) Plan Checklist, Publication 4531.

Designated Roth Accounts under a 401(k) or 

403(b) Plan, Publication 4530, discusses this 

popular feature found in many 401(k) and 403(b) 

plans.

Retirement Plans for Small Business (SEP, 

SIMPLE, and Qualifi ed Plans), Publication 560.

To view these related publications, go to the 

Retirement Plans Community Web page at 

www.irs.gov/ep and click on “EP Forms/Pubs/

Products” in the left pane.
U.S. Department of Labor

Publication 4806 (10-2009)

Catalog Number 53787K