Established under Section 144(1) of the Income Tax Act, the employee profit sharing plan is a special purpose trust that allows the beneficiaries of the plan to share in the profits of a company.
The allocations to an EPSP are taxable in the hands of an employee, and a deductible expense for an employer. EPSPs are non-registered savings plans in which the employer contribution is computed by reference to company profits. The minimum employer contribution is one per cent of current year profits or $100 per employee per year.
Under an EPSP, investment earnings are taxable, any vesting rules or withdrawal restrictions may be established, and no maximum contribution limits or investment restrictions apply. Both employer and employee contributions are permitted- however employer contributions are taxable as income to the employee and tax deductible as a compensation expense to the company.
Advantages of the EPSP
- They attract neither Employer/Employee Canada Pension Plan or EI contributions.
- They allow for more control over retirement assets. They are treated as pension and /or RRSP eligible earnings.
- Source deductions and withholdings are not required by the EPSP trustee or employer.
- The allow for income splitting opportunities.
- All amounts paid from an EPSP to an employee are not subject to a reasonableness test, unlike salaries.
- The “kiddie tax” rules should not apply to income received by minor children from an allocation from an EPSP, if they are bona fide employees of the business.
- Contributions to the EPSP can be made up to 120 days after a corporate year end.
How it works
A trust called the Employee Profit Sharing Plan for XYZ Company is set up using a threeperson trust agreement. The company makes the contribution to the trust.
All funds in the trust account must be allocated to the participants of the plan at the end of the fiscal year. The company issues a T4PS (profit sharing) slip. These earnings are RRSP and IPP eligible.
Loss or reduction of EI and CPP benefits can be offset by properly investing the savings. In most cases flexibility to invest these contributions should more than make up for the lost benefits.
What you need to know
The chart above shows what working Canadians and their employers have been contributing to CPP and EI.
Case study-a practical application for investing CPP contributions
Imagine the owner of a Canadian Controlled Private Corporation establishes an employee profit sharing plan for the year 2006.
In the first year both this business owner and his spouse are the only beneficiaries of the plan, and each earn more than $41,000 of profit-sharing income (through the EPSP trust).
The business owner, his spouse and his CCPC will not need to make any further CPP contributions. After establishing the EPSP the savings will include employer/ employee CPP contributions equaling 3,722.40 each, or $7,444.80 combined.
If the business owner decides to invest the $7,444.80 CPP savings into a balanced portfolio that earned 7.5 per cent annually within an Individual Pension Plan or RRSP within 10 years he will have accumulated $15,344.
Now let us take this a step further. If our owner invests both the employer and employee CPP contribution into an RRSP each year in the same balanced portfolio that compounds annually at 7.5 per cent, assuming his contributions will rise with the average industrial wage rate of 2.5 per cent per year for the next 25 years until he turns 69 years old and has to withdraw funds from a RRIF, our owner will have contributed $254,305 into his RRSP that would have been ear-marked for CPP contributions. The value accumulated within his RRSP before it needed to be commuted into a RRIF at age 70 would be $679,390.
Lastly, imagine that this business owner decides to keep the investments mix within his RRIF the same that earns 7.5 per cent annually. From age 70 to 100 our business owner will be able withdraw a total of $1,772,590 in RRIF payments and there will be a remaining balance in the plan at age 101 of $131,977.
Case study two-income splitting opportunity Note: Difference in net tax payable and net family income with EPSP: is $15,275 in 2006 dollars. The tax savings could even be greater if the business owner employed his children and they where members of the EPSP as well.
If the business owner and his spouse invested their combined savings of taxes and CPP contributions of $22,719.80 ($15,275 tax savings plus $7,444.80 CPP contribution savings) into RRSPs, and the portfolio compounded annually at 7.5 per cent, assuming their contributions rise with the CPI rate of three per cent per year for the next 15 years until they retire, at age 69 when they will have to start withdrawing these funds from a RRIF. The value accumulated within his RRSP would have grown to $2,173,498.
If he keeps the investments mix within his RRIF the same growing at 7.5 per cent annually, from age 70 to 100 he will be able withdraw a total of $5,670,854 in RRIF payments and there will be a remaining balance in the plan at age 101 of $422,220.
Obviously, EPSP requires a specialty in areas such as accounting, legal, employment and tax law and employee benefit plan construction.
Many employers and their accounting professionals will need to seek educational services to aid them in the EPSP setup, maintenance and wind-up stages. Therefore, it is worth the time and money to hire an employee benefit consultant to assist in the design, implementation, maintenance and wind-up of an EPSP solution.