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How a 401(k) Profit Sharing Plan Works
A 401(k) profit sharing plan combines employee salary deferrals, $24,500 for 2026 plus catch-ups, with a discretionary employer contribution the company sets each year, up to $72,000 of total annual additions per participant and an employer deduction of 25% of eligible payroll under IRC 404(a)(3). The employer chooses an allocation formula, funds it by the return due date and files Form 5500.
A 401k profit sharing plan is one plan with two doors. Employees walk in through payroll, deferring part of each paycheck. The employer walks in once a year with a contribution it decides on its own, sized to the year's profit and allocated by a formula written into the plan document. The combination is what lets an owner reach the $72,000 annual limit while the company keeps control of how much it spends. This post covers the two streams, the deduction limit, the allocation formulas and the testing each one triggers, the safe harbor designs, the 2026 Roth catch-up rule, and the deadlines. The comparison with SEP, SIMPLE and defined benefit plans is in retirement plans for business owners.
The two contribution streams and the 2026 numbers
Employee deferrals are capped by section 402(g) at $24,500 for 2026. A participant who is 50 or older by year end may add an $8,000 catch-up, and one who reaches age 60, 61, 62 or 63 during 2026 may add $11,250 instead (Notice 2025-67). The employer profit sharing contribution is discretionary; the plan states the formula, and the company decides the amount each year, including nothing. Everything credited to a participant in the year, deferrals and employer money together but not catch-ups, is limited by section 415(c) to the lesser of $72,000 or 100% of compensation (IRC 415(c)(1)), and the plan may count no more than $360,000 of any participant's pay (IRC 401(a)(17)). Deferrals exist only through payroll: the election has to be made before the pay is available (Treas. Reg. 1.401(k)-1(a)(3)(iii)), and the withheld amounts become plan assets as soon as they can reasonably be segregated, which for a plan with fewer than 100 participants is deemed met when the deposit lands within 7 business days of the pay date (29 CFR 2510.3-102(a)(2)). A payroll that computes, withholds and remits the deferrals each cycle is the plan's plumbing; Managed Payroll does that from $25 per employee per month.
| Limit | 2026 | Code section |
|---|---|---|
| Employee elective deferrals | $24,500 | 402(g)(1) |
| Catch-up, age 50 and over | $8,000 | 414(v)(2)(B)(i) |
| Catch-up, ages 60 to 63 | $11,250 | 414(v)(2)(E)(i) |
| Annual additions per participant (deferrals plus all employer money, excluding catch-ups) | $72,000 | 415(c)(1)(A) |
| Compensation counted per participant | $360,000 | 401(a)(17), 404(l) |
| Highly compensated employee threshold (2025 compensation for 2026) | $160,000 | 414(q)(1)(B) |
| Roth catch-up wage threshold (2025 FICA wages for 2026 catch-ups) | $150,000 | 414(v)(7)(A) |
The employer deduction limit: 25% of compensation under IRC 404(a)(3)
The company's deduction for profit sharing contributions is limited to “25 percent of the compensation otherwise paid or accrued during the taxable year to the beneficiaries under the stock bonus or profit-sharing plan” (IRC 404(a)(3)(A)(i)(I)), with each participant's pay counted up to $360,000 (IRC 404(l)). It is a plan-wide test, not a per-person test: 25% of total eligible payroll is the ceiling, however it is allocated. Elective deferrals are outside the limit entirely and are not taken into account in applying it (IRC 404(n)). Contributions above the limit are not lost; they are carried to later years, but a 10% excise tax under section 4972 can apply to the nondeductible amount, which is why the profit sharing contribution is usually sized after payroll for the year is known.
Allocation formulas, and the testing each one needs
Every qualified plan must not discriminate in favor of highly compensated employees, a term that for 2026 means anyone who owned more than 5% of the business in 2025 or 2026 or earned more than $160,000 in 2025 (IRC 414(q); Notice 2025-67). How the employer contribution is split determines how that rule is proved.
| Formula | How it allocates | Testing it needs |
|---|---|---|
| Pro rata | The same percentage of compensation to every participant | Meets the nondiscrimination-in-amount rule by design (Treas. Reg. 1.401(a)(4)-2(b)(2)); the plan still runs the ADP and ACP tests on deferrals and matches unless it is a safe harbor plan, and the top-heavy test |
| Integrated (permitted disparity) | A base percentage on all compensation plus an extra percentage on compensation above an integration level no higher than the Social Security wage base | Meets the rule by design if the extra percentage is no more than the lesser of the base percentage or the greater of 5.7 points and the old-age insurance rate (IRC 401(l)(2)); same ADP, ACP and top-heavy tests |
| New comparability (cross-tested) | Different percentages for different groups, typically higher for owners, tested on projected benefits rather than contributions | Must pass the minimum allocation gateway: every NHCE gets at least one third of the highest HCE rate, or a flat 5% of compensation (Treas. Reg. 1.401(a)(4)-8(b)(1)(vi)), then the general test each year; same ADP, ACP and top-heavy tests |
The deferral side has its own test whatever the formula: the ADP test compares the average deferral rate of highly compensated employees with the average for everyone else, and passes if the HCE average is no more than 1.25 times the NHCE average, or within 2 percentage points and no more than twice it (IRC 401(k)(3)(A)(ii)); the ACP test does the same for matching contributions. A plan is top-heavy when key employees hold more than 60% of the account balances (IRC 416(g)), and a top-heavy plan must give each non-key participant at least 3% of pay (IRC 416(c)(2)).
Safe harbor designs
A safe harbor 401(k) skips the ADP test, and the ACP test for matches that stay within the safe harbor terms, in exchange for a required, fully vested employer contribution and an annual notice. The statute offers two contribution formulas: a match of “100 percent of the elective contributions of the employee to the extent such elective contributions do not exceed 3 percent of the employee's compensation” plus 50% of deferrals between 3% and 5%, or a nonelective contribution of at least 3% of compensation to every eligible non-highly compensated employee whether or not they defer (IRC 401(k)(12)(B), (C)). A qualified automatic contribution arrangement under 401(k)(13) pairs automatic enrollment with a slightly different match. The nonelective version can even be added late: a plan may be amended to adopt the 3% nonelective safe harbor up to 30 days before the plan year ends, or later with a 4% contribution (IRC 401(k)(12)(F)). The IRS adds that a safe harbor plan that makes no other contributions in a year is exempt from the top-heavy rules (IRS, 401(k) plan overview). Profit sharing sits on top of any of these: the safe harbor contribution handles the deferral testing, and the discretionary contribution is allocated by the formula the plan chose, with the testing that formula requires.
The Roth catch-up requirement for higher earners, starting with 2026
SECURE 2.0 section 603 added IRC 414(v)(7): a participant whose FICA wages from the employer for the preceding calendar year exceeded $145,000, indexed, may make catch-up contributions only as designated Roth contributions, and a plan that does not offer Roth catch-ups cannot let those participants make catch-ups at all (IRC 414(v)(7)(A), (B)). The indexed threshold for 2025 wages, which governs 2026 catch-ups, is $150,000 (Notice 2025-67). The statute applied from 2024, but Notice 2023-62 treated 2024 and 2025 as an administrative transition period, so 2026 is the first year plans must actually apply it. The final regulations, T.D. 10033, apply to contributions in taxable years beginning after December 31, 2026 and impose a reasonable, good faith standard before then (IRB 2025-40). SEP and SIMPLE plans are outside the rule. For a payroll department the practical step is a flag on every participant with 2025 Box 3 wages over $150,000 from this employer, and a Roth deferral source in the plan before the first 2026 catch-up is withheld.
Deadlines to set up and fund the plan
An employer that adopts a profit sharing plan after the close of the year but before the return due date, including extensions, “may elect to treat the plan as having been adopted as of the last day of the taxable year” (IRC 401(b)(2)), and a contribution made by that same due date is deemed made on the last day of the year (IRC 404(a)(6)). That rescues the employer contribution, not the deferrals, which can only come out of pay that is not yet available when the election is signed. A 401(k) feature that starts in October therefore captures three months of deferrals in its first year; a plan that starts in January captures twelve. The profit sharing amount itself can be decided and funded in the following year, after the books close, up to the extended due date of the return. Plans that adopt the safe harbor need the notice in front of employees a reasonable period before the plan year, deemed satisfied between 30 and 90 days before it begins (IRS, 401(k) plan overview).
Form 5500 basics
The plan files an annual return on the Form 5500 series, due on the last day of the seventh month after the plan year ends, July 31 for a calendar-year plan, with an extension of up to 2½ months available on Form 5558 (IRS, Form 5500 corner). Plans with fewer than 100 participants that meet the eligibility conditions file Form 5500-SF, and a one-participant plan covering only an owner, or an owner and spouse, files Form 5500-EZ once its assets exceed $250,000 at the end of the year (Instructions for Form 5500-EZ). Every version is filed electronically through the Department of Labor's EFAST2 system. The return reports the plan's participants, assets and operations; the nondiscrimination and top-heavy tests are performed by the plan's administrator each year and kept with the plan records rather than filed.
A labeled illustration: an owner and two employees
| Item | Amounts | Result |
|---|---|---|
| Owner deferral plus age-50 catch-up | $24,500 + $8,000 | $32,500 |
| Pro rata profit sharing at 10% of pay | Owner $20,000; employees $6,000 and $4,500 | $30,500 employer cost |
| Owner annual additions (catch-up excluded) | $24,500 + $20,000 | $44,500, under the $72,000 limit |
| Pro rata profit sharing at 23.75% of pay, the rate that fills the owner to $72,000 | Owner $47,500; employees $14,250 and $10,687.50 | $72,437.50 employer cost |
| Employer deduction limit: 25% of $305,000 of eligible pay | Deferrals do not count against it | $76,250, so both employer amounts are deductible |
| Owner total at the 23.75% rate | $24,500 + $8,000 + $47,500 | $80,000 |
The pro rata formula fills the owner to the limit only by giving the employees the same 23.75%, about $24,900 between them. A new comparability design could give the employees the 5% gateway, $5,250 in total, and test the owner's 23.75% on a benefits basis; whether it passes depends on the ages of everyone in the plan, which is the calculation a third-party administrator runs before the formula is chosen. An owner who wants more than $72,000 a year is usually looking at a cash balance plan stacked on the 401(k). A first plan with employees may also earn the startup credits described in SECURE Act tax credits. Licensed tax professionals at BEG's tax partner size the contribution against the year's profit as part of Forward Tax Planning with your CPA.
Anthony leads sales at Business Executive Group, a national HR services firm that runs payroll and 401(k) deferrals for growing companies. Tax planning work is done by licensed tax professionals at BEG's tax partner.
Sources: 26 U.S.C. 401(a)(4), (a)(17), (b)(2), (k)(3), (k)(12), (k)(13) and (l); 26 U.S.C. 402(g), limitation on elective deferrals; 26 U.S.C. 404(a)(3), (a)(6), (l) and (n), deduction limits for profit-sharing plans; 26 U.S.C. 414(q) and (v), highly compensated employees; catch-up contributions; 26 U.S.C. 415(c), limitation for defined contribution plans; 26 U.S.C. 416, top-heavy plans; 26 CFR 1.401(a)(4)-2(b)(2), safe harbor for plans with a uniform allocation formula; 26 CFR 1.401(a)(4)-8(b)(1)(vi), minimum allocation gateway for cross-tested plans; 26 CFR 1.401(k)-1(a)(3)(iii), timing of cash or deferred elections; 29 CFR 2510.3-102, definition of plan assets; participant contributions (deposit timing); IRS, Notice 2025-67, 2026 amounts relating to retirement plans; IRS, T.D. 10033, catch-up contributions (final regulations), IRB 2025-40; IRS, 401(k) plan overview (plan sponsor), reviewed August 4, 2026; IRS, Form 5500 corner, reviewed July 20, 2026; IRS, 2025 Instructions for Form 5500-EZ. Figures and rules checked against these sources on September 26, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.
401(k) profit sharing plan questions
How much can go into a 401(k) profit sharing plan for one person in 2026?
$72,000 of annual additions, counting the employee’s deferrals and every employer dollar, plus catch-up contributions on top: $8,000 at age 50 and over, or $11,250 for a participant who reaches age 60, 61, 62 or 63 during 2026. That makes $80,000 or $83,250 for an owner with enough pay, since the employer piece is also limited to 25% of the owner’s compensation under the deduction rules.
Does the employer have to make a profit sharing contribution every year?
No. A profit sharing contribution is discretionary; the plan document sets the formula and the employer decides the amount, including zero, each year. Two things are not discretionary: a safe harbor contribution the plan promises, and the 3% top-heavy minimum for non-key employees when the plan is top-heavy and the employer contributes anything for key employees.
What is the 25% deduction limit, and do salary deferrals count against it?
IRC 404(a)(3) limits the employer’s deduction for profit sharing contributions to 25% of the compensation paid during the year to the plan’s participants, counting no more than $360,000 per person for 2026. Elective deferrals do not count against that limit and are not treated as employer contributions for it (IRC 404(n)), so a company can deduct the employees’ deferrals in full and still use the whole 25% for profit sharing.
What is a new comparability profit sharing plan?
A plan that puts participants in groups and gives each group a different contribution rate, then proves it is nondiscriminatory by testing the projected benefit at retirement instead of the contribution today. Because a younger employee’s dollar has longer to grow, an older owner can receive a higher rate. The price is the gateway: every non-highly compensated employee must get at least one third of the highest HCE rate or 5% of pay, and the plan must pass the general test every year.
Do higher earners have to make catch-up contributions as Roth in 2026?
Yes, if their FICA wages from the employer in the prior year exceeded the threshold, $150,000 of 2025 wages for 2026 catch-ups (Notice 2025-67; IRC 414(v)(7)). Notice 2023-62 treated 2024 and 2025 as an administrative transition period, so 2026 is the first year the rule bites. The final regulations, T.D. 10033, apply to contributions in tax years beginning after December 31, 2026 and allow a reasonable, good faith interpretation before then. A plan that does not allow Roth catch-ups cannot let those participants make catch-ups at all.
Can I set up a 401(k) profit sharing plan after year end and still get a deduction for that year?
For the employer contribution, yes: a plan adopted after year end but before the return due date, including extensions, may be treated as adopted on the last day of the year (IRC 401(b)(2)), and a contribution made by that due date is deducted for that year (IRC 404(a)(6)). Salary deferrals cannot be backdated; an election covers only pay that is not yet available when the election is made (Treas. Reg. 1.401(k)-1(a)(3)(iii)).
When is Form 5500 due for a 401(k) plan?
On the last day of the seventh month after the plan year ends, July 31 for a calendar-year plan, with a one-time extension of up to 2.5 months on Form 5558. Plans with fewer than 100 participants that meet the conditions file the short Form 5500-SF, and a one-participant plan files Form 5500-EZ once its assets exceed $250,000 at year end. All of them file electronically through EFAST2.
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