Nothing in Code §125 or the IRS cafeteria plan regulations addresses how an FSA account should be treated in the event of a corporate merger or acquisition. However, the IRS has provided some guidance in the form of a revenue ruling and informal comments. Therefore, some generalizations can be made based on how the transaction is structured (e.g., as an asset purchase or stock purchase).
There are three basic types of merger and acquisition transactions:
- Asset Purchase The buyer purchases the assets and (if agreed) the liabilities of the seller.
- Stock Purchase The buyer purchases all of the stock or other ownership interest in the business.
- Merger Two businesses merge into one. Often in connection with a stock purchase.
The type of transaction influences how to handle the underlying plans, and may dictate what can or cannot be done with participant elections and FSA account balances.
An asset purchase may involve acquiring all the seller’s assets or only a portion of the assets. For example, the buyer may purchase the assets of a division or a particular line of business. The seller generally continues to exist as a legal entity after the sale of assets even though it may no longer be engaged in an ongoing business.
When a buyer purchases the assets of an ongoing business, the buyer often hires the employees of the seller as well even though this is not legally required. Depending on its goals, the buyer may pick the employees it wants, offering employment to all or only some. In an asset sale, the employment of the seller’s employees is considered terminated, even if they are immediately rehired by the buyer. The employees who go along with the assets become employees of the new legal entity.
Employees of the acquired business will terminate their employment with the seller. These employees may be offered participation in an existing or new cafeteria plan maintained by the buyer. The buyer might also adopt a “mirrored” version of the seller’s plan or, if the acquired business maintains its own benefit arrangements, the buyer might assume sponsorship of these programs. Here are some issues to be considered.
a. Cafeteria Plan Elections
If employees of the acquired business will cease to participate in the seller’s cafeteria plan upon the closing of the transaction, their cafeteria plan elections would likely terminate at that time. New salary reductions elections should be obtained from these employees under the buyer’s existing cafeteria plan or a mirrored plan adopted by the buyer, as applicable. (If a mirrored plan is adopted, perhaps a negative election mechanism could be utilized.) If the employees are to participate in an existing plan of the buyer’s that has a waiting period, the buyer may wish to amend the plan to provide more favorable terms to employees of the acquired business.
In contrast, if the buyer assumes sponsorship of the cafeteria plan covering the employees of the acquired business, elections under the plan would theoretically continue.
b. Health FSAs and IRS Rev. Rul. 2002-32
What happens to transferred employees who were participating in the seller’s health FSA? Unless other arrangements are made, an asset purchase would typically result in termination of participation in the seller’s health FSA account and the possibility of a health FSA account forfeiture (as well as potential COBRA rights under the seller’s health FSA). IRS Rev. Rul. 2002-32provides guidance as to how a buyer and seller in an asset purchase may continue the health FSA coverage of transferred employees under a health FSA of either the seller or the buyer. The ruling describes two scenarios that met with IRS approval.
- Coverage Under Seller’s Health FSA With Salary Reductions Under Buyer’s Plan. In this scenario, the seller has a health FSA funded entirely with employees’ pre-tax salary reductions under a cafeteria plan. During a plan year, it sells a portion of its business assets. The seller continues its business operations after the asset sale and continues to maintain its health FSA. The buyer either has or will create a cafeteria plan that offers health FSA coverage through pre-tax salary reductions. The seller and buyer agree to have the transferred employees continue to participate in the seller’s health FSA for an agreed-upon period (for example, through the end of the plan year). The seller and buyer also agree on the extent to which the original salary reduction elections made under the seller’s plan will continue as if made under the buyer’s plan.
- Coverage and Salary Reductions Under Buyer’s Plan. In this scenario, the buyer agrees to cover the transferred employees under its health FSA for the remainder of the plan year. The employees’ account balances under the seller’s health FSA are rolled over to the buyer’s health FSA. As in the first scenario, the seller continues its business operations after the asset sale and continues to maintain its health FSA. However, all claims for reimbursement after the asset sale are submitted to the buyer’s health FSA (even claims incurred before the asset sale but not yet reimbursed). The transferred employees’ salary reductions continue for the balance of the plan year under the buyer’s plan.
The ruling notes that in each scenario, no mid-year election change is permitted under the permitted election change regulations, because the transferred employees do not lose eligibility for health FSA coverage as a result of the asset sale (they retain eligibility either under the seller’s health FSA or the buyer’s health FSA).Consequently, the transferred employees remain subject to their existing health FSA elections, which may not be changed during the remainder of the plan year (unless another event occurs that would permit an election change under IRS regulations). The ruling prescribes important requirements that must be satisfied if either of its options are used, including plan amendments and COBRA offerings.
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