401(k) Profit Sharing Contributions: What Employers Need to Know in 2026

A profit sharing contribution is the most powerful tool for maximizing 401(k) plan design benefits - for both employees and employers. You decide each year both whether and how much to contribute. Additionally, plan sponsors may determine which employees may receive profit sharing contributions, regardless of whether they make voluntary deferrals. And allocation formulas can direct most of the contribution to business owners while still passing IRS nondiscrimination testing.

Profit sharing allows most small business owners to reach the $72,000 annual additions limit for 2026. Despite requiring the most detailed and complicated design decisions, most employers find using profit sharing contributions the most important - and valuable - part of implementing a 401(k) plan for their business.

This guide follows one small business through those decisions. It covers the limits that cap profit sharing, what each allocation formula costs to get the owner to the maximum, the testing rules behind each formula, and how to pair profit sharing with a safe harbor 401(k).

How 401(k) Profit Sharing Contributions Work

A profit sharing contribution is an employer contribution allocated to eligible employees' 401(k) accounts under a formula in the plan document. It's a type of nonelective contribution, meaning employees receive it whether or not they defer their own pay. That's the key difference from a matching contribution, which only goes to employees who save.

Most profit sharing contributions are discretionary: each year, you decide whether to contribute and how much. What stays fixed is the allocation formula, the rule in your plan document that divides the contribution among eligible employees. You choose the total; the formula decides who gets what.

Profit Sharing Doesn't Require Profits

The term "profit sharing" is a carryover from the pre-1986 tax code. Since 1986, the tax code has allowed contributions to a profit sharing plan without regard to current or accumulated profits (IRC §401(a)(27)). Profitable businesses are not required to contribute. And both businesses with a loss year and tax-exempt organizations may make contributions.

Profit Sharing Contributions vs. Profit Sharing Plans

Technically, a 401(k) plan is a profit sharing plan with a cash-or-deferred arrangement added, and most 401(k) plan documents include a profit sharing feature. A stand-alone profit sharing plan drops the 401(k) feature and accepts only employer contributions. Most small businesses prefer the 401(k) version, because it lets everyone, owners included, defer up to $24,500 of their own pay for 2026 on top of any profit sharing.

Profit Sharing Contribution Limits

Three IRS limits cap profit sharing: two apply to each employee, and one applies to the plan as a whole. All figures are for 2026 (IRS Notice 2025-67).

Annual Additions Limit

Profit sharing counts toward the §415(c) annual additions limit, which caps everything added to an employee's account for the year: deferrals, matching contributions, profit sharing, and allocated forfeitures. For 2026, the limit is $72,000 or 100% of the employee's compensation, whichever is less. Investment earnings and catch-up contributions don't count.

This is the limit profit sharing is built to fill. An owner who defers the full $24,500 can receive up to $47,500 in employer contributions before reaching $72,000. With catch-ups, an owner age 50 or older can reach $80,000, and an owner age 60–63 can reach $83,250. Catch-ups must be Roth for employees, including W-2 owners, whose 2025 FICA wages from the business exceeded $150,000. Employees with lower earnings are also limited by the 100% compensation rule.

Employee Compensation Limit

The §401(a)(17) compensation limit caps the employee compensation that can be used to calculate profit sharing contributions at $360,000 for 2026. For example, a 10% contribution to an owner earning $500,000 would be $36,000 (10% × $360,000), not $50,000.

Employer Deduction Limit

Your business can deduct its employer contributions (profit sharing, plus any match or safe harbor contribution) up to 25% of the total compensation of all eligible employees for the year (IRC §404(a)(3)). Two features of this limit work in your favor:

• • Employee deferrals don't use up the 25%. Only employer contributions count against the limit, and employees' deferrals still count as part of the payroll the 25% is based on (§404(n) and §404(a)(12)).
  • The 25% limit applies to total payroll, not to each employee. With $400,000 of eligible payroll, for example, you can deduct up to $100,000 in employer contributions, however your formula divides that amount among employees. One employee can receive far more than 25% of their own pay, as long as the total stays within $100,000 and each employee stays within the annual additions limit.

If you contribute more than the limit, you can deduct the excess in a later year, but you'll owe a 10% excise tax on it for each year it remains nondeductible (IRC §4972).

Special Limits for Self-Employed Owners

For sole proprietors and partners, compensation is net earnings from self-employment, reduced by the deduction for half of self-employment tax and by the contribution itself. Because the contribution reduces the compensation it's based on, the 25% limit works out to an effective 20%.

For example, a sole proprietor has $150,000 in net earnings after the self-employment tax deduction. The maximum profit sharing contribution is 20% × $150,000 = $30,000. To check the math: $150,000 − $30,000 leaves $120,000 of compensation, and 25% of $120,000 is the same $30,000. With a full $24,500 deferral, the owner's total is $54,500.

S corporation owners count W-2 wages only, regardless of shareholder distributions. A solo S corporation owner paid $190,000 in W-2 wages can receive a $47,500 profit sharing contribution (25% × $190,000), which reaches $72,000 with a full deferral.

Profit Sharing Allocation Formulas

There are three formulas for allocating profit sharing contributions to employees: pro rata, permitted disparity, and new comparability. Small businesses use all three. In our 2022 plan design study of 4,330 small business plans, pro rata (38.09%) and new comparability (34.27%) were the most common formulas in traditional plans, and 68.50% of plans with a safe harbor nonelective contribution used new comparability.

To see how the formulas differ, take a four-person company whose owner wants to reach the $72,000 limit. That takes $47,500 in employer contributions on top of a full $24,500 deferral:

Pro Rata Allocation

A pro rata formula, sometimes called a comp-to-comp formula, gives every eligible employee the same percentage of pay. It's the simplest formula to administer and the easiest for employees to see as fair. The trade-off is cost: the owner's share of the contribution always equals their share of payroll, so raising the owner's contribution raises everyone else's in proportion.

Cost for this company: $47,500 is 19% of the owner's pay, so everyone receives 19%. Staff receive $32,300, and the total cost is $79,800.

Permitted Disparity (Integrated) Allocation

A permitted disparity formula, also called an integrated formula, gives everyone the same base rate, then adds an extra contribution on pay above the Social Security taxable wage base ($184,500 for 2026). Because Social Security benefits replace only pay up to the wage base, IRC §401(l) lets the plan make up the difference above it, at a rate of up to 5.7% (or the base rate, if that's lower).

Cost for this company: None of the staff earn more than the wage base, so only the owner gets the extra 5.7%, on the $65,500 of pay above $184,500 ($3,733.50). The owner reaches $47,500 with a base rate of about 17.5%, which every employee receives. Staff receive $29,761, and the total cost is $77,261, only about $2,500 less than pro rata.

The boost is modest. With the wage base as the threshold, the most it can add for any one employee in 2026 is about $10,000, because of the $360,000 compensation limit. Plans can set a lower threshold, which spreads the extra contribution to more employees, but most lower thresholds also reduce the 5.7% rate to 5.4% or 4.3%.

New Comparability (Cross-Tested) Allocation

A new comparability formula places employees in groups, and each group can receive a different contribution rate, so owners can receive a much higher rate than staff. The trade-off is testing: the allocation must pass an annual nondiscrimination test, which generally requires a minimum contribution for staff, called the gateway, of 5% of pay. The next section explains both.

Cost for this company: The owner receives 19%, and staff receive the 5% gateway, or $8,500. The total cost is $56,000, or $23,800 less than pro rata.

Those savings aren’t guaranteed, because of the nondiscrimination rules that apply to new comparability contributions. The formula works best when owners are meaningfully older than most staff, often by 10 years or more. With younger owners or older employees, staff may need much larger contributions, and the savings over pro rata can shrink or disappear..

Nondiscrimination Testing for Profit Sharing Contributions

Every profit sharing formula must satisfy IRS rules that keep the plan from favoring highly compensated employees (HCEs) over everyone else, called non-highly compensated employees (NHCEs). For 2026, an HCE is generally anyone who owned more than 5% of the business in 2025 or 2026, or who earned more than $160,000 in 2025. Your third-party administrator runs the tests, but three rules shape your design choices:

• Nondiscrimination: contributions can't unfairly favor HCEs.
• Coverage: enough NHCEs must receive a contribution.
• Top-heavy minimum: if owners and other key employees hold more than 60% of plan assets, other employees must receive a minimum contribution.

These rules are separate from the ADP and ACP tests, which cover employee deferrals and matching contributions.

Nondiscrimination Requirements for Profit Sharing Contributions

Pro rata and permitted disparity formulas usually satisfy the nondiscrimination requirements that apply to profit sharing contributions automatically. Because a new comparability formula gives different groups different rates, it must pass the IRS general nondiscrimination test.

Most plans pass it by cross-testing, which compares contributions by the retirement benefit they'll buy at retirement age, usually 65 (Treas. Reg. §1.401(a)(4)-8). A young employee's contribution has more years to grow, so a small contribution for a 26-year-old can test as equal to a much larger one for a 55-year-old owner. That's why employee ages largely determine how much new comparability can save.

Cross-testing requires a gateway minimum: each NHCE who receives an allocation must get at least 5% of pay, or one-third of the highest rate any HCE receives, if that's less. In our example company, the owner receives 19%, and one-third of 19% is 6.33%, so the gateway is the full 5%.

Coverage Requirements for Profit Sharing Contributions

Profit sharing can require allocation conditions, most commonly 1,000 hours of service in the year, employment on the last day of the year, or both. Employees who don't meet them receive no profit sharing that year, which controls cost and rewards employees who stay. Safe harbor contributions can't carry these conditions.

The catch is the IRC §410(b) coverage test. Employees who miss an allocation condition count against the plan, and the percentage of NHCEs who receive a contribution generally must be at least 70% of the percentage of HCEs who do. Employees who quit during the year after working 500 or fewer hours can generally be left out of the test. If turnover still causes a failure, a fail-safe provision in many plan documents adds employees back to the allocation until the plan passes.

Profit Sharing Impact on Top-Heavy Contributions

A plan is top-heavy when key employees hold more than 60% of plan assets. In a top-heavy year, every non-key employee who is a plan participant and employed on the last day of the plan year must receive a minimum contribution of 3% of pay (or less, if no key employee receives 3%, counting deferrals). An hours requirement can't be used to withhold it.

Profit sharing counts toward that minimum. A profit sharing contribution of at least 3% of full-year pay satisfies it for everyone who receives one. Employees excluded by an allocation condition still need the minimum if they're employed on the last day.

Adding Profit Sharing to a Safe Harbor 401(k) Plan

The owner in our example also wants to defer the full $24,500, which a traditional plan's ADP test may not allow. A safe harbor 401(k) solves that: its required employer contribution exempts the plan from ADP/ACP testing, and profit sharing fills in the rest. That's why safe harbor plus profit sharing is the most common way small business owners reach the $72,000 limit.

The safe harbor formula you choose changes the cost of new comparability profit sharing:

Safe Harbor Nonelective Plus Profit Sharing

A 3% safe harbor nonelective contribution goes to every eligible employee and counts toward the new comparability gateway (Treas. Reg. §1.401(k)-3(h)(2)). In the example, the owner receives $7,500 in safe harbor and $40,000 in profit sharing, and each staff member receives 3% safe harbor plus 2% profit sharing. The total is the same $56,000 as new comparability alone, but now the owner can also defer the full $24,500 with no ADP/ACP testing.

This pairing explains why only 6.00% of safe harbor nonelective plans in our design study skipped profit sharing, the lowest rate of any plan design. One caution: every NHCE who receives the safe harbor contribution generally needs the full 5% gateway, including employees who miss a profit sharing allocation condition.

Safe Harbor Match Plus Profit Sharing

A safe harbor match doesn't count toward the gateway, because matching contributions are tested separately from profit sharing. Staff still need a full 5% profit sharing contribution, on top of whatever match they earn. In the example, if all three staff members earn the full 4% match, the total cost rises from $56,000 to $62,800.

A safe harbor match still pairs well with pro rata or permitted disparity profit sharing, which have no gateway, and a match often costs less than a nonelective contribution when participation is low. Run both designs before choosing.

Top-Heavy Rules for Safe Harbor Plans

A safe harbor plan is normally exempt from the top-heavy minimum, but adding profit sharing, or allocating forfeitures, ends that exemption for the year (Rev. Rul. 2004-13). With a 3% safe harbor nonelective, this usually adds no cost, because every eligible employee already receives 3%. With a safe harbor match, it can: an employee who misses a profit sharing allocation condition but is employed on the last day, and doesn't earn at least a 3% match, must still receive a 3% top-heavy contribution.

Profit Sharing Vesting and Forfeitures

Once you've chosen a formula, two operating decisions remain: how fast contributions vest, and when you fund them. Unlike most safe harbor contributions, profit sharing can be subject to a vesting schedule, so unvested money stays in the plan when employees leave early.

Vesting Schedules

Profit sharing may use a 3-year cliff or 6-year graded vesting schedule as the longest period, but faster schedules are always allowed. Under a 6-year graded schedule, an employee is 20% vested after two years of service and gains 20% a year until reaching 100% after six.

Regardless of service, profit sharing becomes 100% vested when an employee reaches normal retirement age, when the plan terminates (or a partial termination affects the employee), or when the employer completely discontinues contributions (see "Skipping a Year" below).

How Forfeitures Are Used

When a partially vested employee leaves, the unvested part of their account is forfeited. Your plan document controls how forfeitures are used: to pay plan expenses, to reduce future employer contributions (including safe harbor contributions), or to reallocate to remaining participants.

Forfeitures can't sit in the plan indefinitely. IRS regulations proposed in 2023 set a clear deadline: forfeitures generally must be used within 12 months after the end of the plan year in which they occur. The rules aren't final yet, but the IRS has said plans may rely on them in the meantime. Follow your plan document exactly; forfeiture use has become a litigation target for large plans.

When to Deposit Profit Sharing Contributions

Profit sharing deposits are controlled by company tax deadlines (unlike employee deferrals):

• • Deductibility: Deposit by your business's federal income tax filing deadline, including extensions, to deduct the contribution for the prior year (IRC §404(a)(6)). For a calendar-year S corporation or partnership, that's March 15, or September 15 with an extension. For a C corporation or sole proprietor, it's April 15, or October 15 with an extension.
  • Annual additions: Deposit within 30 days after that deduction deadline for the contribution to count toward the plan year's §415(c) limit.

Many employers deposit during the year, such as quarterly, to spread out the cash flow, and allocate at year-end. See our 401(k) contribution deadlines guide for every deadline in one place.

Deciding the Amount After Year-End

Because profit sharing is discretionary, you can wait until you know your profits and tax picture to decide how much to contribute. Record the decision in writing, such as a board resolution or written consent of the owners.

If your 401(k) document doesn't include a profit sharing feature, you can still add one for the year just ended. Since 2024, a plan amendment that adds or increases employer contributions (other than matching contributions) for the prior plan year can generally be adopted as late as your business's tax filing deadline, including extensions (IRC §401(b)(3)).

Adopting a Profit Sharing Plan After Year-End

A business that doesn't sponsor a retirement plan has a similar option. Thanks to the SECURE Act, it can adopt a new profit sharing plan as late as its tax filing deadline, including extensions, and elect to treat it as adopted on the last day of the prior tax year (IRC §401(b)(2)). A calendar-year S corporation that extends its 2026 return could adopt a plan as late as September 15, 2027, and deduct a profit sharing contribution for 2026.

Retroactive adoption covers employer contributions only. Employee deferrals can't be made for a year that's already over, with one exception: a sole proprietor (including a single-member LLC) who is the business's only employee can make deferrals for the plan's first year until their individual tax return due date, not including extensions.

Skipping a Year

You can skip a discretionary profit sharing contribution without amending the plan or notifying employees, which isn't true of a safe harbor contribution. But IRS rules expect profit sharing contributions to be recurring and substantial (Treas. Reg. §1.401-1(b)(2)). If they stop, the IRS can treat the plan as having a complete discontinuance of contributions, which makes affected participants 100% vested (IRC §411(d)(3)).

There's no bright-line rule, but the IRS has said a plan may have a complete discontinuance if the employer hasn't made contributions in three of the past five consecutive years. It also considers the business's profitability and the likelihood of future contributions. Employee deferrals don't keep a plan out of this review; the IRS looks at employer contributions.

Roth Profit Sharing Contributions

Profit sharing has historically been pre-tax. Since SECURE 2.0, a plan can let employees elect to receive nonelective contributions, including profit sharing, as Roth contributions, under these rules (IRS Notice 2024-2):

• • The contribution must be 100% vested when made. Vesting is based on an employee's years of service, so an employee who has already completed the plan's vesting schedule (three years of service under a 3-year cliff, for example) is 100% vested in every new contribution and can elect Roth. Employees still working toward full vesting can't.
  • The employee owes income tax on it for the year it's allocated. It's reported on Form 1099-R, not the W-2, and isn't subject to FICA or income tax withholding, so employees may need to adjust their withholding or estimated taxes.
  • Like other Roth 401(k) money, it can be withdrawn tax-free, earnings included, as a qualified distribution.

Not every provider and payroll system supports Roth employer contributions yet. Plans that already allow them must be amended by December 31, 2026. For details, see our guide to Roth matching and nonelective contributions.

When to Use Profit Sharing Contributions

Profit sharing and matching contributions solve different problems, and many plans use both. Here's how to decide where profit sharing fits.

When Profit Sharing Makes Sense

Profit sharing is usually the right tool when your goal is owner savings, flexibility, or a benefit for everyone:

• • Owners want to save more than the deferral limit. Profit sharing is the most practical way to get from $24,500 to $72,000.
  • Your profits vary. A discretionary contribution can rise in good years and disappear in lean ones.
  • You want to reach employees who don't defer. Profit sharing reaches every eligible employee, including those who can't afford to save.
  • You want to reward employees who stay. Vesting schedules and allocation conditions concentrate contributions on longer-service employees.

Profit Sharing vs. a Cash Bonus

Against a year-end cash bonus, the tax math favors profit sharing. Employer contributions to a qualified plan aren't subject to Social Security or Medicare taxes (IRC §3121(a)(5)), they're deductible like wages, and employees pay no income tax until they withdraw the money (unless they elect Roth). On a $5,000 bonus, you'd pay $382.50 in FICA tax and the employee would lose another $382.50 plus income tax withholding; as profit sharing, the full $5,000 reaches the employee's account. (The FICA savings apply to employees only; a sole proprietor's or partner's own contribution doesn't reduce self-employment tax.) The trade-off is that employees can't spend the money now, and it may be subject to vesting.

When a Match May Be a Better Fit

A 401(k) match tends to fit better when your goal is participation:

• • You want employees to save. A match rewards deferrals; profit sharing doesn't.
  • Your plan struggles to pass ADP testing. A match encourages NHCEs to defer more, which helps the test. Ordinary profit sharing doesn't count in the ADP test; only fully vested qualified nonelective contributions (QNECs) can be used to help pass it.
  • Participation is low and the budget is tight. A match costs nothing for employees who don't defer.

Final Thoughts

Profit sharing gives you more control than any other employer contribution: how much to contribute, when to decide, who receives it, and how fast it vests. The allocation formula is where that control pays off. In our example, new comparability got the owner to $72,000 for $56,000 in employer contributions, $23,800 less than pro rata, with or without a 3% safe harbor nonelective. The best formula for your business depends on your workforce: how old your owners are compared with your staff, how much they earn relative to the Social Security wage base, how many employees you have, and how often they turn over.

If you're designing a new plan or want to see what your owners could contribute, talk with our team about which profit sharing formula fits your goals, or request a quote to see how affordable a well-designed small business 401(k) can be. Our guide to 401(k) matching contributions is a good next read, too.