A new comparability profit-sharing plan is a qualified retirement plan that lets an employer contribute a different percentage of pay to different groups of employees, typically steering larger allocations to owners and senior staff while giving the rest of the workforce a smaller required minimum. It stays tax-qualified only if it clears an annual nondiscrimination test using a method called cross-testing, meets a gateway minimum contribution for non-highly compensated employees, and satisfies the top-heavy rules that apply to most closely held plans.
Who Counts as Highly Compensated
The design begins by splitting the workforce into rate groups, each assigned its own contribution percentage. Groupings must follow objective business criteria such as job title, department, or years of service rather than pick out individuals, because the IRS evaluates fairness at the group level.
The dividing line that matters most is between Highly Compensated Employees (HCEs) and Non-Highly Compensated Employees (NHCEs). You are an HCE if you owned more than 5% of the business at any point during the current or prior plan year, or if your compensation from the employer exceeded $160,000 during the lookback year (the year before the plan year being tested). For a plan year beginning in 2026, the lookback year is 2025, and that $160,000 threshold applies.1Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs – Notice 2025-67 The employer may elect to limit the compensation test to the top-paid 20% of employees.2Internal Revenue Service. Identifying Highly Compensated Employees in an Initial or Short Plan Year Everyone who fails both tests is an NHCE.
How Different Contribution Rates Work
A traditional profit-sharing plan gives every eligible participant the same percentage of pay. New comparability abandons that uniformity. One group might receive 15% of compensation while another receives 5%, and the plan can still qualify if the testing works out.
Age is what makes the numbers hold up. A dollar contributed today for a 30-year-old has roughly 35 years to grow before retirement at 65, while the same dollar for a 55-year-old has only 10 years. The testing rules project today’s contributions forward to retirement age and compare projected benefits rather than current dollars, so the math naturally favors plans that give higher current rates to older employees: it takes a much larger current contribution to produce the same projected benefit over a shorter time horizon. The design works best when the people the employer wants to reward are older than the broader workforce.
Cross-Testing and the Nondiscrimination Rule
The legal backbone of the plan is cross-testing. IRC Section 401(a)(4) requires that contributions or benefits under a qualified plan not discriminate in favor of highly compensated employees.3Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans Section 410(b) separately requires the plan to benefit a broad enough cross-section of the workforce.4eCFR. 26 CFR 1.401(a)(4)-1 – Nondiscrimination Requirements of Section 401(a)(4)
Cross-testing satisfies 401(a)(4) by converting each participant’s current contribution into an Equivalent Benefit Accrual Rate, or EBAR. The calculation projects the contribution forward to a normal retirement age (typically 65) using a standard interest rate between 7.5% and 8.5%, converts the accumulated amount into an equivalent annual retirement annuity, and divides by current compensation. The result is a percentage representing the equivalent retirement benefit that contribution buys. A younger employee’s smaller contribution can produce an EBAR comparable to an older employee’s much larger contribution. When the EBARs across groups fall within acceptable ranges, the plan passes.
That is the actual leverage. A $5,000 contribution for a 28-year-old can project to a similar retirement benefit as a $20,000 contribution for a 58-year-old, so the plan can show nondiscriminatory benefits while the current dollar allocations look wildly unequal.
Gateway Minimums for Rank-and-File Employees
Before the plan gets to cross-testing, it must clear the minimum allocation gateway. This threshold exists to keep employers from using the cross-testing math to give NHCEs almost nothing. Treasury Regulation 1.401(a)(4)-8(b)(1)(vi) offers two paths.5GovInfo. Internal Revenue Service, Treasury 1.401(a)(4)-8 – Cross-Testing
- Five percent safe harbor: every NHCE receives an allocation of at least 5% of compensation. Hitting this mark satisfies the gateway automatically, no matter how high the HCE rates go.
- One-third rule: every NHCE’s allocation rate is at least one-third of the highest allocation rate given to any HCE. If the top HCE group gets 18%, each NHCE needs at least 6%.
The 5% safe harbor is simpler to administer and is what most plans use. The one-third rule can produce a lower required NHCE allocation when HCE rates are modest, but it becomes more expensive than the safe harbor once HCE rates exceed 15%. Failing the gateway means the plan cannot use cross-testing at all and must show nondiscrimination based on current contribution rates, which almost always fails for a plan built on tiered allocations.
Top-Heavy Minimums
Most new comparability plans end up classified as top-heavy, meaning more than 60% of total plan assets belong to key employees (owners and officers above certain compensation thresholds). When that happens, IRC Section 416 requires the employer to contribute at least 3% of compensation for every non-key employee who is eligible and employed on the last day of the plan year.6Office of the Law Revision Counsel. 26 US Code 416 – Special Rules for Top-Heavy Plans
One exception: if the highest contribution rate for any key employee is below 3%, the minimum drops to match. That exception rarely helps a new comparability plan because the whole point of the design is giving key employees high contribution rates.
The gateway minimum and the top-heavy minimum overlap but are not identical. A plan that gives every NHCE 5% clears both. A plan using the one-third rule at a 9% top HCE rate produces a 3% NHCE allocation that clears the gateway and just meets the top-heavy floor. Both requirements have to be checked separately each year.
Federal Contribution and Deduction Caps
Several federal ceilings limit what can go into the plan regardless of the rates the employer assigns to each group.
- Annual additions limit: total contributions for any single participant cannot exceed $72,000 for 2026 under IRC Section 415(c).7Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
- Compensation cap: the plan can only count the first $360,000 of any participant’s pay when calculating contributions for 2026. Someone who earns $500,000 has an allocation formula applied only to $360,000.1Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs – Notice 2025-67
- Employer deduction limit: the employer can deduct contributions up to 25% of the total compensation paid to all plan participants during the tax year. Contributions above that threshold are not deductible and trigger a 10% excise tax.8Office of the Law Revision Counsel. 26 US Code 404 – Deduction for Contributions of an Employer to an Employees Trust or Annuity Plan
These interact in design. The highest-rate group’s allocation has to stay within the $72,000 per-person cap, no participant’s countable compensation can exceed $360,000, and total employer contributions across all groups cannot exceed 25% of aggregate participant compensation without losing deductibility.
Vesting Choices
Employer contributions do not have to belong to the employee immediately. IRC Section 411 allows the plan to impose a vesting schedule that decides how much of the employer contribution a participant keeps if they leave before reaching full vesting.9Office of the Law Revision Counsel. 26 US Code 411 – Minimum Vesting Standards Two options set the maximum permissible delay:
- Three-year cliff vesting: participants own 0% until they complete three years of service, then become 100% vested all at once.
- Two-to-six-year graded vesting: participants vest 20% after two years and an additional 20% each year, reaching 100% after six.
Plans can vest faster, including immediate 100% vesting on the date of contribution. Regardless of schedule, any participant who reaches normal retirement age or whose plan terminates must become fully vested at that point.
Vesting carries more weight here than in a traditional design because the dollar amounts can be large. An owner receiving a $50,000 annual allocation is fully vested by definition, since owners are always 100% vested in their own contributions. An NHCE receiving a $4,000 gateway contribution under a three-year cliff walks away with nothing after two years. Employers with high turnover among rank-and-file staff sometimes choose cliff vesting deliberately, since forfeitures from departing employees can reduce future contribution costs.
Annual Filings and Deadlines
Each year the employer sends year-end payroll data and an updated employee census to the plan’s third-party administrator or actuary. The administrator runs the cross-testing calculations, confirms the gateway minimums, checks Section 410(b) coverage, and verifies top-heavy status. This work typically happens in the first few months after the plan year closes.
Employer contributions must be deposited by the due date of the employer’s federal tax return, including extensions.10Internal Revenue Service. Issue Snapshot – Deductibility of Employer Contributions to a 401(k) Plan Made After the End of the Tax Year For calendar-year S corporations and partnerships, that is March 15, or September 15 with an extension. For calendar-year C corporations, it is April 15, or October 15 with an extension. The contribution is allocated as if it were made on the last day of the plan year even though the cash moves later.
Form 5500 must be filed electronically with the Department of Labor by the last day of the seventh month after the plan year ends. For a calendar-year plan, that is July 31. A one-time extension of up to two and a half months is available by filing Form 5558 before the original deadline.11U.S. Department of Labor. Instructions for Form 5500 Late or missing filings carry civil penalties of up to $2,670 per day under ERISA.12U.S. Department of Labor. Fact Sheet – Adjusting ERISA Civil Monetary Penalties for Inflation
When the Plan Fails Testing
A plan that fails its annual nondiscrimination testing risks losing tax-qualified status. Disqualification would make all employer contributions immediately taxable to participants and non-deductible to the employer, so plans almost always correct rather than accept that outcome.
The most common fix is additional contributions for NHCEs. The employer deposits Qualified Non-Elective Contributions (QNECs) sufficient to lift NHCE allocation rates to a passing level. QNECs must be 100% vested immediately and allocated uniformly as a percentage of compensation across all eligible NHCEs. Reducing or redistributing the HCE allocations is the alternative, though it is messier because money already deposited to individual accounts may have to be recharacterized.
The IRS Employee Plans Compliance Resolution System provides a formal framework for correcting plan errors. Operational failures caught and corrected promptly may qualify for self-correction without an IRS filing. Longer-running failures or those involving significant dollar amounts may require a formal submission. Either way, corrective contributions cost real money, and an employer whose testing repeatedly comes down to the wire should look at whether the rate structure needs a permanent adjustment rather than an annual patch.