Employee Profit Sharing Plans vs. Employee Benefit Plans: What's the Difference?

Key takeaways

• An Employee Profit Sharing Plan (EPSP) allows employers to share profits with employees through a trust
• EPSP allocations to employees are fully taxable as employment income in the year allocated — they are not tax-deferred
• The employer deducts contributions to the EPSP trust; employees pay tax on allocations, not withdrawals
• EPSPs are distinct from Deferred Profit Sharing Plans (DPSPs), which allow deferral
• Contributions to an EPSP reduce the employee's RRSP contribution room via a pension adjustment

Employee Profit Sharing Plans are a way for employers to share profits with employees in a tax-deductible manner, but they are often misunderstood. Unlike a pension plan or DPSP, an EPSP does not defer tax for the employee — allocations are taxable immediately, even if the cash remains in the trust.

How an EPSP works

The employer establishes a trust and contributes a portion of profits to the trust. The trustee (often a financial institution) allocates the trust's earnings among participating employees according to the plan terms. Each employee pays income tax on their share of the allocation for that year, reported on a T4PS slip. The actual cash payout may be deferred under the plan terms — but the tax is not deferred.

An EPSP is sometimes confused with a bonus plan because both are funded from profits. The difference is that an EPSP is a formal trust arrangement, has specific CRA registration requirements, and generates a pension adjustment that reduces RRSP room. A bonus is simpler and has no impact on RRSP room.

EPSP vs. DPSP

A Deferred Profit Sharing Plan (DPSP) actually defers tax. Employer contributions to a DPSP are not taxable when made; employees pay tax only when they withdraw funds. DPSPs are restricted to employer contributions only — no employee contributions — and are subject to vesting rules and DPSP limits (18% of current year compensation, to a maximum equal to the RRSP dollar limit). Both plans reduce RRSP room through pension adjustments.

Tax on split income concerns

A TOSI (tax on split income) risk exists when the plan is used to shift income to related lower-income employees — particularly family members of business owners. CRA has targeted arrangements where an EPSP is used primarily to sprinkle income to family members rather than share genuine profits with arm's-length employees. Ensure the EPSP has legitimate profit-sharing purposes and reasonable allocations.