A new twist in profit-sharing plans makes it possible for small business owners to skew the greatest chunk of benefits to company principals, rather than allocating the money in proportion to salaries. In many cases, this means more tax-deferred income will flow to company presidents and their top aides.
The ability to sweeten the pot for top management is made possible by the emergence of so-called "age- and salary-weighted" profit-sharing plans. Management can use such plans to boost benefits for employees with the most seniority and the highest salaries. The impact can be significant.
Under a straight pro rata arrangement, each employee's share of the plan contribution is in direct proportion to his share of the payroll.
An example: Assume ABC Co. has three employees, making $100,000, $30,000 and $20,000 each. Because the top earner makes two-thirds of the company's $150,000 payroll, he is entitled to two-thirds of the profit-sharing contributions.
The second type of standard plan seeks to boost the principals' stake by integrating contributions with Social Security payments. This allows employees earning above the Social Security wage base ($53,400 in 1991) to receive a larger proportion of the plan dollars.
For this reason, ABC's top earner could extend his share of the pot from 66 percent to about 71 percent.
"That's a significant increase, but it hardly matches the bang you can get out of age- and salary-weighted plans in companies where the principals are substantially older than the rank-and-file," says David Gensler, president of White Plains, N.Y.-based Madison Pension Services.
"Here's why. Assume ABC's top earner is 50 years old and the other employees are 35 and 25 years of age. Because the senior person will retire much sooner, the plan can accelerate benefits to him, meaning he could claim as much as 90 percent of the contribution," Gensler explained.
Says Barry Cosloy, a partner with the benefits consulting practice of Coopers & Lybrand, CPAs, "With standard plans using Social Security integration, contributions for those employees earning above the FICA wage base can only be twice as great as the contribution percentage for those employees earning below this baseline.
But age- and salary-weighted plans allow contribution percentages for higher earners to be four or five times those made for the rank-and-file, he adds.
Although the concept of age- and salary-weighted profit-sharing plans has been around for years, the first proposed regulations outlining how these plans should be structured were issued by the Internal Revenue Service last May.
"Before the IRS acted, plan administrators had to work within a gray area, structuring plans and seeking their approval one at a time," Gensler says.