Profit-sharing plans allow your employer to put money into a retirement account for you without bumping up your taxable income in the year of the contribution. However, when you take out the money, it's time to pay up. You'll receive a Form 1099-R that documents the distribution, and it needs to be included on your taxes. The rate you pay depends on your marginal tax rate.
Distributions from profit-sharing plans count as ordinary income for federal income tax purposes. This means there are no special income tax rates for distributions, nor is there one single rate that applies to all your withdrawals. The distributions can't count as capital gains no matter what you invested the money in when it was in the profit-sharing plan. Instead, the distributions get added to your other taxable income for the year and taxed at your marginal tax rate.
The tax rate applied to your profit-sharing distribution depends on your income tax bracket. The higher your total income, the higher your tax rate on your profit sharing distribution. As of 2013, the tax rates go as high as 39.6 percent for singles making more than $400,000 and joint filers making more than $450,000. Your profit-sharing withdrawal might push you into a higher tax bracket, but that higher rate only applies to the portion of your income that falls in that bracket. For example, say you're in the 25 percent bracket, just $5,000 under the 28 percent bracket, without your profit-sharing distribution. If you take out $25,000, the first $5,000 is taxed at 25 percent and the remaining $20,000 is taxed at 28 percent.
If you're under 59 1/2 years old, the IRS might tack on another 10 percent tax penalty on your distribution from your profit-sharing plan. Though you're allowed to get the money out before then, Uncle Sam discourages you from raiding your retirement plan early by adding this tax penalty -- unless you qualify for an exception. For example, say you want some extra money for a down payment on a bigger home. If you take $25,000 out of your profit sharing plan, you'll owe an extra $2,500 on your taxes -- in addition to the ordinary income taxes.
Not all early withdrawals from profit-sharing plans get hit with an extra 10 percent penalty: if you qualify for an exception, you're off the hook on the penalty but you still owe the ordinary income taxes. You won't owe the penalty on any distributions taken after you suffer a permanent disability or distributions taken by your beneficiaries after your death. You can also take out qualified reservist distributions without penalty. Plus, if your medical expenses exceed 10 percent of your adjusted gross income, you won't owe the penalty on the portion of your withdrawal used to pay those medical bills.
- Internal Revenue Service: Choosing a Retirement Plan: Profit-Sharing Plan
- Internal Revenue Service: Topic 558 - Additional Tax on Early Distributions from Retirement Plans, Other Than IRAs
- Internal Revenue Service: Topic 502 -- Medical and Dental Expenses
- Forbes: IRS Announces 2013 Tax Rates
- Georgia State University: Basic Tax Rate Concepts
- AXA Equitable: How do Company Profit-Sharing Plans Work?
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