Employer profit-sharing gives an employee extra money based on the employer's profits, so the employee has an additional incentive to work harder. The employer can decide whether to distribute the money to employees immediately or to place it in a separate trust to provide a retirement benefit. Some profit-sharing plans allow deferred compensation, so the employee doesn't pay taxes on the income until after retirement, when the employee's income tax rate is lower because the employee doesn't earn wage income.
When the employer establishes a separate trust to store the shared profits, the employer also hires managers to earn extra income on the money in the trust. According to the IRS, hiring these fund managers adds administrative costs, reducing the income that employees receive from the plan. The managers can purchase stocks, bonds and other investments, so the trust gains or loses money when the value of the stocks and bonds changes in the market.
A profit-sharing arrangement that distributes a cash bonus or funds a retirement trust is optional for the employer. Employers offer profit-sharing as an extra incentive to recruit skilled workers. The employer may also establish this plan as a bonus to reward stellar work performance.
Profit-sharing distributions don't qualify as deferred income for federal income tax purposes if executives receive a greater share of income from the plan, in proportion to their salaries, than office workers get. According to the U.S. Code, an employer can offer profit-sharing to workers who receive a salary or to office workers without making it available to other workers, such as factory workers who receive pay by the hour, and the plan still keeps its tax advantages.
An employer that creates a profit-sharing plan doesn't have to fund the plan every year. According to Brigham Young University, the employer may decide not to add any money to the trust in a year when it loses money. Some profit-sharing plans use a formula based on the profit the company earns in a year to determine how much money the company will add to the trust; others place money in the trust only when the company's directors specifically authorize it.
Contribution With a Loss
The employer doesn't have to actually earn a profit to contribute to the profit-sharing plan. According to the IRS, the directors can still add money to the trust even if the firm has a loss, although it's more likely that directors will fund the trust if the firm earns a profit.