New Tax Rule Ties Executive Pay Deductions to 5% Employee Profit-Sharing Mandate

The Employee Profit-Sharing Encouragement Act of 2025 is trying to change the math on corporate compensation. Simply put, this bill introduces a new financial requirement for companies that want to write off their biggest executive salaries on their taxes.

Starting in the first taxable year after enactment, if a company wants to deduct the cost of compensation paid to its highly compensated executives, it must first prove it has a qualified profit-sharing plan in place for its general employees. No profit-sharing? No tax deduction for the CEO’s salary. This is a direct tax mechanism designed to force the distribution of corporate profits down the ladder.

The 5% Rule: What Employees Get

For a company’s profit-sharing plan to be “qualified” under this bill, it has to meet a few key requirements that affect your wallet. First, the total amount distributed to employees for that tax year must be at least 5 percent of the company’s net income (as shown on its books). Second, the distributions must be calculated based on a measure of the company’s receipts, profit, or revenue. This isn't a bonus based on individual performance; it’s a share of the company’s overall success.

Who gets the money? Employees must have worked for the company for at least one year to be eligible, and the plan must adhere to strict nondiscrimination rules, similar to those governing 401(k) plans. This means the money can't just go to a select few mid-level managers; it has to be spread fairly across the workforce. For the average employee, this could mean an annual cash payment tied directly to the company’s bottom line, which is a significant change from standard bonus structures.

The Corporate Catch-22

This bill applies to any employer that meets the gross receipts test of section 448(c) of the Internal Revenue Code, which covers most large-to-midsize businesses. For these companies, the choice is clear: either implement a profit-sharing plan that gives away at least 5% of net income, or lose the ability to deduct potentially massive executive pay packages. Since losing that deduction means paying significantly more in corporate taxes, this bill creates a very strong incentive for companies to start sharing profits.

But there’s a catch. Companies can skip the profit-sharing if they can prove to the IRS, using “clear and convincing evidence,” that making the distributions would jeopardize the company’s ability to stay in business. This “solvency exception” is a necessary lifeline for struggling firms, but how strictly the IRS enforces the “clear and convincing” standard will determine if this exception becomes a loophole.

The Anti-Abuse Clause and Real-World Impact

Whenever legislation mandates a new payment to employees, the immediate question is: Will companies just cut base wages or other benefits to cover the cost? The bill attempts to preempt this by giving the Treasury Secretary (and thus the IRS) the authority to create anti-abuse rules. This means the IRS can step in if it looks like a company is simply shuffling money around—reducing your regular paycheck just to meet the 5% profit-sharing mandate.

For businesses, especially those with complex compensation structures, this bill introduces significant compliance costs. They will have to implement new accounting and distribution systems, and potentially restructure executive pay. For executives, this could mean their total compensation package gets scrutinized or even reduced to offset the new cost to the company. Ultimately, this bill is a heavy-handed, tax-based approach to ensuring that when a company does well, the people who actually run the operation—the employees—get a guaranteed piece of the action.