The Tax Rates on Cashing Out of Profit Sharing

Some companies offer a profit sharing bonus plan to their employees as part of a benefits package. Generally, employers contribute money to the account, which operates on a deferred-tax basis, and they receive a tax benefit for doing so. When you decide to withdraw the money, you'll have profit sharing tax consequences, and depending on your age and other factors, a possible tax penalty. Understanding profit sharing vs bonus implications can help you plan a responsible financial strategy.

Understanding Basics of Profit Sharing

Profit sharing plans give employees a share of their employer's profits and a sense of ownership in the company's success. Profit sharing plans are generally qualified plans, meaning that the money contributed by your employer has not been taxed. When you take out the money, you'll pay income taxes at that time, at whatever tax rate corresponds to your income level. This could be advantageous if you'll be in a lower tax bracket once you retire.

Finding Your Tax Bracket

Your applicable tax bracket depends on the amount of total income you earn for the given tax year. In the tax year 2020, these range from ​10 percent​ for income up to ​$9,875​ and to ​37 percent​ for income over ​$518,400​.

While the tax bracket gives you an idea of the tax percentage you'll pay, you need to complete your tax return to factor in all of your income sources and apply any tax credits or deductions that could lower your adjusted gross income, and subsequently, your total tax liability. You'll need the IRS tax tables to determine your tax owed once you've filled in your profit sharing income and other information on your tax return.

Considerations for Fund Withdrawals

If you've withdrawn some of your profit-sharing funds before retirement, you might be on the hook for a ​10 percent​ penalty from the IRS. If you left your employer at age ​55​, however, you can take the distributions and pay your regular tax without penalty. You can also roll the plan into another qualified plan with no penalty.

If you're still on the job, however, you'll need to pay the penalty for early distributions. If you are at least ​59 1/2​ years old, you will only pay your standard income tax rates. However, if you have not yet reached this age you will be forced to pay an additional ​10 percent​ penalty on your withdrawal.

Certain other conditions allow you to avoid the penalty if withdrawing before the minimum retirement age of ​59 1/2​. These include disability, being called to active duty as a military reservist, or using the money to pay an existing tax liability. Other conditions include a divorce settlement, medical costs or the death of the plan owner.

Reporting Your Taxes

Each year, you'll receive IRS tax Form 1099-R, which details distributions from your retirement plan. Your employer sends a copy of this form to both you and the IRS, with information about any money that's been distributed to you from your profit sharing account. You must report the information in 1099-R box 2a, "Taxable Amount," on your tax return. The amount of taxes you'll owe depends on the tax bracket in which your income falls for the given tax year.