Some companies offer a profit sharing 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 income tax consequences, and depending on your age and other factors, a possible tax penalty.
What's a Profit Sharing Plan?
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.
Relevant Tax Forms
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.
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Your Tax Bracket
Your applicable tax bracket depends on the amount of total income you earn for the given tax year. Tax brackets have changed somewhat with the establishment of the Tax Cuts and Jobs Act of 2017, although the new brackets won't be applicable until you file your return for the 2018 tax year.
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.
Withdrawing Funds Before Retirement
If you've withdrawn some of your profit-sharing funds before retirement, you might be on the hook for a 10 percent penalty from the IRS.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. 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.