What Is a Profit-Sharing Plan?

The purpose of this plan is to specify what share of a business's profit savings employees will receive, what requirements need to be met for eligibility and other details. Many businesses, large or small, set up profit-sharing plans as it can reduce their tax liabilities. The plan is meant to outline everything from the distribution of the payout to the agreements that need to be met for eligibility. So if you're going to make this type of plan, be sure to cover everything that involves what will be distributed and how.

How to Create a Profit-Sharing Plan?

1. Determine the Purpose of the Plan

Many profit-sharing plans are designed as a retirement benefit for employees. Then there are some who make the plan to simply motivate employees into working harder for the company or another which predetermined share of the profits is paid directly via the employee's overall wages. You are going to have to decide which one you would like to go for so that you'll have an idea as to how you should go about in setting everything up.

2. Explain How One Can Be Eligible For the Plan

Not every employee can be a part of the profit-sharing plan as that will jeopardize one's overall profits. You need to make it clear as to what will determine whether one is qualified for the eventual payment or not. One example of a requirement is that the employee has to have been with the company for more than a year in order to be eligible. You can even consider which positions are automatically entitled to join the plan and what agreements need to be made before they can be a part of it.

3. Come Up With the Formula

It is important that you think about the formula that will be used to allocate the profits among the employees. It's typical for companies to determine that 10 to 15 percent of their pre-tax profits will be eligible for distribution. Know that this is something that you don't necessarily have to follow. You have to consider the company's financial situation and the target revenue to meet in order to know how much should be contributed. Also, don't forget to think about the share holders as you still need to make sure that the company has enough earnings to increase in terms of value.

4. Consider the Allocation Date and How Exiting Employees Will Be Paid

Know that you can decide whether or not employees who leave the company before the allocation date will be paid. You can set up an agreement that an employee must not leave before the allocation date if he/she wishes to gain any profits owed. This is a form of security so that you won't be sharing your profits to someone who quits early. Then you'll need to consider when exactly the employees will receive their allocation payment. This will depend on the type of plan you're going for as you might be pointing out a specific date every year or you might state that it'll come whenever employees wages are due.

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