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Profit Sharing Plans

What are Profit Sharing Plans?Profit-Sharing-Plans

Employers use profit sharing plans as a way of rewarding good performance of their employees. They are used to instill a sense of partnership between the employer and each participating employee in the pursuit of maximum profits.

Four types of Profit Sharing Plans:

  1. Cash Profit Sharing Plans

  2. Employee's Profit Sharing Plans

  3. Deferred Profit Sharing Plans

  4. Registered Profit Sharing Pension Plans

Why Establish a Profit Sharing Plan?

There are many types of business structures that range from a small business with just a few employees to large public companies with thousands of employees. Large public companies use incentives to motivate their employees, increase productivity and maximize profits. Publicly traded company will use incentives that include stock options, bonuses or a combination of both. Stock options are paid with company shares, bonuses are paid with cash.

Regardless of how big your company is all companies can benefit from profit sharing plans to motivate their employees, increase their productivity and maximize profits. Small businesses that do not want the administrative burden and costs associated with setting up a sophisticated profit sharing plan can still benefit from the same strategies used by large corporations.

The simplest profit sharing plan is a cash distribution profit sharing plan. An employer can use this incentive to reward employees directly in proportion to their contribution to the company's profits. In this arrangement small business owners do not have to relinquish control of the company, they use cash to reward their employees. Cash profit sharing plans do not require registration of the plan with Canada Revenue Agency.

Regardless of the type of plan the company wishes to implement, we would advise all companies and business owners to obtain professional accounting and legal advice. There are many strategies and pitfalls in these arrangements. Canada Revenue Agency has specific rules governing each plan type. Employee Profit Sharing Plans (E.P.S.P.'s) have come under scrutiny by Canada Revenue Agency. Employers used employee profit sharing plans (E.P.S.P.'s) by making distributions to family members to avoid paying taxes, CPP contributions and other payments.

One of the fundamental requirements of any profit sharing plan is that payments from the employer be computed by reference to profits. Profit sharing plans that require registration and setting up a trust require that a formula be put in place that governs what the annual contributions will be. There are specific rules and guidelines governing the computation formula to compute benefits for profit sharing plans.

Stone-Hedge Financial Group Inc. does not provide any legal or accounting advice. We will work with accountants and tax lawyers to help clients implement the right profit sharing plan for their business.

Cash or Current Distribution Profit Sharing Plans 

Cash or Current Distribution Profit Sharing Plans are designed to provide periodic cash distribution to plan members based on the profits of the employer.

  1. Profit sharing payments are made directly to the employee in cash or stock certificates;

  2. Taxation is not deferred and occurs in the year that moneys are paid out or stock certificates issued;

  3. The payment of these moneys is linked to the services provided by the employees in their daily work that assist the employer in earning a profit;

  4. Earnings will be allocated to the week or weeks in which the services were performed;

  5. Does not require registration with Canada Customs and Revenue Agency. 

Employee's Profit Sharing Plans (E.P.S.P.)

In Employee's Profit Sharing Plans a share of the profits each year is placed in a trust fund and allocated to participating employees along with their share of the accumulated interest in the fund for that year.

  1. Allocation may be in proportion to the employee's earnings, length of service, or some other formula;

  2. Moneys generally remain in the trust fund until the participant's employment is terminated, some plans allow cash withdrawals while still employed;

  3. Employees may also make contributions to this fund. Employee contributions are not tax deductible to the employee;

  4. Vesting of the employer's profit sharing contributions can be immediate, only on death, termination of employment, or retirement. In cases where vesting is not immediate cash withdrawals cannot be made by employees while employed, they have no right to these payments.

  5. The employee is taxed each year on his or her share of the profits, the interest accruing in the trust, and any realized capital gains, as if he or she was in immediate receipt of such moneys;

  6. There is no income tax payable on any employee contributions made to this fund these moneys come from the employee's after-tax income;

  7. Profit sharing plans are registered under section 144 of the Income Tax Act;

  8. Payment of earnings is linked to the services provided by the employees in their daily work that assist the employer in earning profits;

  9. Earnings will be allocated to the week or weeks in which the services were performed in proportion to the share in profits that arose from the performance of services and accrued interest in the trust account.

Deferred Profit Sharing Plans

In a Deferred Profit Sharing Plan (DPSP), the employer allocates a share of the profits to all participating employees each year and places it in a trust account. These moneys remain in the trust account until the participant's employment is terminated. Effective January 1, 1991, employee contributions to this plan are no longer allowed except for direct transfers from other registered tax-assisted plans.

  1. Taxation of the employee's share of the profits and the interest accrued in the trust fund is deferred until the employee is in receipt of these moneys.

  2. Deferred profit sharing plans are registered under section 147 of the Income Tax Act, and are subject to more regulation and control than Employee's Profit Sharing Plans.

  3. To qualify for registration the Deferred Profit Sharing Plan must:

      1. Provide for full vesting within two years, immediately at retirement, or disability. Contributions made on or after January 1, 1991, must vest immediately if the member has completed twenty-four (24) months of membership in their deferred profit sharing plan;

      2. define a normal retirement age, with annuity or instalment payments to begin no later than age 71;

      3. follow strict investment rules comparable to those for pension plans; and

      4. provide for significant employer contributions when profits are realized. A deferred profit sharing plan allows for withdrawal of all or part of an employee's account while still in active employment. This is not allowed under a pension plan. The entire withdrawal above the employee's own contributions is then taxed as income.

  4. On termination of employment or retirement a lump-sum payment out of a deferred profit sharing plan is taxed as income. The employee has the option to purchase an annuity or transfer the funds to an individual RRSP and benefit from additional tax deferral. A lump sum payment is not available on termination of employment or retirement in a pension plan.

  5. Moneys in a deferred profit sharing plan are earnings that arise out of employment they are not considered as payable until the actual distribution is made to the employee.

  6. The payment of these earnings is linked to the services provided by the employee in their daily work that assist the company in earning profits.

  7. As the share in the profits arose from the performance of services, these earnings will be allocated to the week in which the services were performed.

Registered Profit Sharing Pension Plan 

A Registered Profit Sharing Pension Plan is a type of money purchase pension plan in respect of which employer contributions are related in some way to profits. The provisions under which these plans operate are the same as for other pension plans that are subject to pension legislation.

  1. The profit sharing aspect of the pension plan is solely a method of funding. Any moneys placed in the fund must remain there until retirement or termination of employment.

  2. Profit Sharing Pension Plans are registered under section 147.1 of the Income Tax Act, as are all other pension plans.

  3. Employee and employer contributions are tax deductible. Interest income in the trust fund accumulates tax deferred. All benefits are taxable when paid out. In some cases benefits must be paid in the form of annuities and only on retirement, lump-sum payments are available in exceptional circumstances. The maximum contribution amount that is deductible from taxable income is the same as for other pension plans.

  4. Payments made from a Registered Profit Sharing Pension Plan are earnings as they have all the characteristics of a pension that arises out of employment.

  5. Payment from these plans will be handled in the same manner as any payment out of a pension fund: as a periodic pension; as a lump-sum pension benefit; and as a return of contributions.

  6. If the employee should terminate his or her employment prior to retirement age, any locked-in pension credits are transferred directly to a locked-in vehicle, they are not considered to be payable until they are paid.

Ontario Resources

Financial Services Commission of Ontario

Glossary - Pension Terms

Profit Sharing Plan Comparison

Cash or Current Distribution Plan

Employee's Profit Sharing Plan

Deferred Profit Sharing Plan

Registered Profit Sharing Pension Plan

DISTRIBUTION:

Cash or shares in the stock of the company are periodically distributed

DISTRIBUTION:

Accumulates in a trust fund along with interest

DISTRIBUTION:

Accumulates in a trust fund along with interest

DISTRIBUTION:

Accumulates in a trust fund along with interest

TAXATION:

Taxed with wages and other benefits when paid

TAXATION:

Taxed each year on share of profits and accumulated interest in the trust fund

TAXATION:

Taxed only when money is paid out

TAXATION:

Taxed only when money is paid out

REGISTRATION:

Not registered under the Income Tax Act

REGISTRATION:

Registered under section 144 of the Income Tax Act

REGISTRATION:

Registered under section 147 of the Income Tax Act

REGISTRATION:

Registered under section 147.1 of the Income Tax Act

ACCESS: immediately as paid out to employee ACCESS: on termination or retirement or sometimes during employment ACCESS: on termination or retirement or sometimes during employment ACCESS: only on termination or retirement as there is no access while employed

EARNINGS?

Regulation 35(2)

EARNINGS?

Regulation 35(2)

EARNINGS?

Regulation 35(2)

EARNINGS?

Regulation 35(2)(e)

ALLOCATION:

Regulation 36(6)

ALLOCATION:

Regulation 36(6)

ALLOCATION:

Regulation 36(6)

ALLOCATION:

Regulation 36(14)

Regulation 36(15) and 36(17)

Source: Government of Canada 

Digest of Benefit Entitlement Principles 

Date modified:2013-07-25

 

Contact Us to Set Up or Review Your Profit Sharing Plan

 


The information provided on this web site is intended for general information only. It should not be construed as legal, accounting, tax or specific insurance and investment advice. Clients should consult a professional advisor concerning their situations and any specific insurance and investment matters. While reasonable steps have been taken to ensure that this information was accurate as of the date hereof, Stone-Hedge Financial Group Inc. and its affiliates make no representation or warranty as to the accuracy of this information and assume no responsibility for reliance upon it.







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