Five Clues That Profit Sharing May Work for You

As wages rise, profit-sharing plans could help small businesses compete for workers.

Back Web Only Aug 26, 2015 By Steven Yoder

With or without state minimum-wage hikes, big companies are boosting hourly rates for their lowest-paid workers. Last year, Gap and Starbucks both announced pay increases. In January, Aetna bumped up its lowest-paid staff from $12 to $17 an hour. The following month, Walmart said its base pay would go to $10 an hour by 2016. Then in April, McDonald’s told workers that by 2016 average pay in 1,500 company-owned stores would rise to $10 an hour.

But competing with big-league firms for employees is tough — average pay at small businesses runs about two-thirds that offered at other companies. Not keeping up with pay hikes elsewhere can create staff turnover, eating into morale and creating operational problems.

Enter profit-sharing plans. Broadly, these take two forms: employee bonuses or retirement plans. The former are considered taxable income to the recipient, while the latter are tax-deferred until employees retire. More information on what’s involved in setting up the retirement option is available from the U.S. Department of Labor.

Here are five indicators that a profit-sharing plan might be right for your business:

1. You’re profitable. Don’t laugh. For revenue-sharing to work, you actually have to make money now and expect to clear a profit for at least the next three years, says David Wray, former president of the Plan Sponsor Council of America in an interview. “If you announce the plan and you have no profit sharing for a couple of years, it loses its credibility as a motivating force.”

2. You’d like to increase staff commitment to the company. Money may not buy love, but employees \tend to care more about the health of your business when doing so translates into a bigger bank account for them. A 2013 review of available studies concluded that profit-sharing plans positively affected turnover, absenteeism and employee attitudes.

3. You’ve got longtime employees who can’t go much higher in salary. Some companies with skilled older staff may not be able to pay them more because they’ve maxed out their salary increases and are at the top tier of their employee class, says the National Federation of Independent Business. A profit-sharing plan can get around that by offering them bonuses or retirement benefits.

4. You’re in a business with a lot of back-office staff. If the majority of your company’s success depends on a lot of interaction with customers, a profit-sharing plan may not be a good fit. That’s because of the well-documented free-rider problem in any profit-sharing scheme. For example, a restaurant that requires wait staff to split tips at the end of the night could dilute its incentives by rewarding less-skilled staff, says the NFIB. But in a business with a lot of back-office work in which worker productivity and effectiveness are more easily monitored and measurable — say, a printing company — profit-sharing works better.

5. You’re looking for new ways to cut your tax bill. Profit-sharing lets you leverage extra money you give to employees to slash what you owe the government. A business owner’s contributions to a profit-sharing plan generally can be written off if those contributions stay under a quarter of total compensation paid, according to the U.S. Department of Labor. “While the personal tax savings is sometimes what makes a plan financially feasible in the eye of the owners, the resulting employee contributions also help employees prepare for retirement,” says Ken Roberts of Nicholas Pension Consultants in Rancho Cordova.