When it comes to mergers and acquisitions involving at least one applicable large employer (ALE), the substantive rules governing employer shared responsibility (under Internal Revenue Code § 4980H) and the corresponding reporting rules (under Internal Revenue Code § 6056) share at least one thing in common: we don’t yet know how they work. This leaves parties to corporate deals with some challenging questions: How should acquired employees be treated? Does the form of the transaction matter? Do “successor employer” rules of the sort found in the COBRA final regulations apply? Are the parties free to apportion exposure? What presumptions might be invoked if the matter of Affordable Care Act (ACA) compliance is not addressed? What exactly was Tom Brady’s role in “deflate gate”?
A recent program sponsored by the American Bar Association Center for Continuing Legal Education on the subject of the ACA reporting rules included a discussion of the reporting aspects of mergers and acquisitions in which Treasury Department and IRS representatives participated. Because the official position of the government may only be enunciated in formal written guidance, the opinions voiced by the government representatives were not binding. They were, rather, their own informal views. The program nevertheless provided some useful hints as to how mergers and acquisitions would be treated for ACA purposes.
Background—what we do know
That the ACA’s employer shared responsibility rules will play a role in mergers and acquisitions is clear from the statute. Code § 4980H(c)(2)(C)(iii) provides that, for purposes of determining whether an employer is an ALE, any reference to an employer includes a reference to any predecessor of the employer. In addition, in the case of an asset deal, a purchaser may become responsible for certain of the seller’s tax, benefits and employment liabilities under the successor employer doctrine, this despite that the asset purchase agreement expressly excludes these liabilities by its terms.
Predecessor and successor employers
Here is what the final regulations under Code § 4980H have to say about predecessor and successor employers:
“Predecessor employer. [Reserved]” Treas. Reg. § 54.4980H-1(a)(36).
The preamble to the final regulation is modestly more forthcoming. It reads, in relevant part:
“As with the proposed regulations, the final regulations reserve with respect to specific rules for identifying a predecessor employer (or the corresponding successor employer). The Treasury Department and the IRS continue to consider development of rules for identifying a predecessor employer (or the corresponding successor employer), and until further guidance is issued, taxpayers may rely upon a reasonable, good faith interpretation of the statutory provision on predecessor (and successor) employers for purposes of the applicable large employer determination. For this purpose, use of the rules developed in the employment tax context for determining when wages paid by a predecessor employer may be considered as having been paid by the successor employer (see § 31.3121(a)(1)–1(b)) is deemed reasonable.” 79 Fed. Reg. p. 8,548 (Feb. 12, 2014).
Under the successor employer rules set out in Treas. Reg. § 31.3121(a)(1)–1(b), where an employee works for more than one employer during the calendar year, the combined amount of wages subject to the employee portion of the Social Security tax is capped at the Social Security wage base. There is no exception permitting an employer to reduce or eliminate withholding the Social Security tax from the employee’s wages when the employee receives wages from a second employer or multiple employers during the calendar year, even when the employee has reached the Social Security wage base taking into account wages paid by another employer or a combination of employers. There is rather a mechanism for claiming a refund on the employee’s individual income tax return.
An exception applies in the case of an asset sale. For purposes of determining whether a successor employer has reached the Social Security wage base, the successor employer is allowed to take credit for the wages that a predecessor employer paid to an employee during the calendar year if the following conditions are satisfied:
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The successor acquired substantially all the property used in a trade or business or used in a separate unit of a trade or business, of the predecessor;
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The employee was employed in the trade or business of the predecessor immediately prior to the acquisition and is employed by the successor in its trade or business immediately after the acquisition; and
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The wages were paid during the calendar year in which the acquisition occurred and prior to the acquisition.
The successor employer doctrine
In the benefits context, the best known instance of the successor employer doctrine arises under COBRA. In an asset sale, where the seller or a related entity continues to maintain a health plan, terminating employees who lose health coverage are entitled to be offered COBRA, even if hired by the buyer and offered coverage under the buyer’s plan. If neither the seller nor any related entity has a group health plan following an asset sale, and the buyer continues the business operations associated with the purchased assets without interruption or substantial change, the buyer is considered a successor employer and responsible for COBRA coverage.
The Final Code § 4980H regulations and Notice 2014-49
The final Code § 4980H regulations include extensive and complex rules that apply to an employee who experiences a change in employment status, from a position for which the look-back measurement method is used, to a position for which the monthly measurement method is used (or vice versa). But the final regulations did not address whether, or under what conditions, an employer that uses a measurement method for a category of employees may subsequently change that measurement method. Instead, the preamble to the final regulations makes the following promise:
“The Treasury Department and the IRS anticipate that the rules with respect to a transfer from a position to which one lookback measurement method applies to a position to which another look-back measurement method applies will require complex rules because the methods may differ not only in the length of the applicable measurement and stability periods, but also the starting dates of the measurement periods. . . . To provide for these rules in the most comprehensible format, as well as to ensure flexibility to address situations that arise that have not currently been contemplated, the final regulations provide that with respect to the determination of full-time employee status, the Commissioner may prescribe additional guidance of general applicability, published in the Internal Revenue Bulletin.”
In Notice 2014-49, the IRS made good on its promise. Specifically, the notice addresses two situations: The first applied to an “Employee transferring from a position to which one measurement period applies to a position to which a different measurement period applies,” and the second relates to “Employer-initiated changes in measurement methods for one or more permissible categories of employees.” (See our previous post on Notice 2014-49 for further explanation.)
At the end of Notice 2014-49, the IRS gives us the following clue as to how they might address mergers and acquisitions:
“Until further guidance is issued, and in any case through the end of calendar year 2016, taxpayers involved in a corporate transaction in which employers use different measurement methods may rely on the approach described in this notice in determining an employee’s status as a full-time employee for purposes of § 4980H. . . .
Recognizing that the approach described in the immediately preceding paragraphs to addressing the consequences of corporate transactions is not necessarily the only permissible approach and might in some cases present practical issues, the Treasury Department and the IRS encourage comments on this and other possible approaches.”
The issue that the IRS addresses here relates to instances in which one of the parties to the deal has chosen to use the look-back measurement method to determine full-time employee status. Where both the buyer and seller have elected to use the monthly measurement method, the merger or acquisition is a non-event.
Some examples—stock and asset deals
Set out below are the examples discussed during the above cited ABA Center for Continuing Legal Education program.
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Stock deal—ALE acquires non-ALE
Alpha Group (an ALE) acquires the stock of Tiny Corp (a non-ALE) in 2015. The question arises, when does Tiny Corp. become an ALE member? And does it matter whether Tiny Corp. is a wholly-own subsidiary of Alpha Group or if Tiny Corp. is merged up into Alpha Group?
The rules governing when an employer becomes an ALE generally look to the prior calendar year. Particularly where Tiny Corp. is maintained as a wholly-own subsidiary of Alpha Group, might Tiny Corp. avoid ALE or ALE member status until 2016? In the regulator’s view at least, the answer was no. Thus, 1095-Cs would need to be provided to Tiny Corp.’s employees. For months prior to the effective date of the deal, Tiny Corp. employees would be coded as not employed (i.e., Code 2A. Employee not employed during the month). It was generally agreed that no substantive pre-merger information would be required, nor would Tiny Corp. have any exposure pre-merger. This result is the same, though marginally more compelling, if Tiny Corp. is merged into Alpha Group.
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Stock deal—ALE acquires ALE
Alpha Group (an ALE) acquires the stock of a subsidiary of Beta Group (which is also an ALE). Since both parties are already ALEs, reporting is required. But what controlled group members are included in Form 1094-C, Part IV filed by Alpha Group, and by Beta Group, the acquired subsidiary? Since the purpose of Form 1094-C, Part IV is to apprise the IRS of any sources of exposure, it is likely any rule that the Treasury Department and IRS adopt will provide that the reporting will include all entities even if not part of the group of employers under common control for the entire year.
Alpha Group (an ALE) acquires the assets of Charlie Co. In connection with the sale, Charlie Co. terminates all of its employees. Alpha Group hires some, but not all, of Charlie Co.’s former employees. Are there any circumstances under which Alpha Group would need to report its newly-hired employees (former Charlie Co. employees) as other than new employees in applying the look-back measurement method?
Based on the above-cited text from Notice 2014-49, it’s pretty clear (to the author at least) that the IRS intends to apply some sort of successor employer rule here. Whether the IRS would be able to enforce such a rule absent further guidance is another matter entirely. In the case of an asset sale, the parties may agree to treat the buyer as a successor employer. But even in this case, it’s not clear whether that would be sufficient to be the basis for exposure for assessable payments under Code § 4980H.
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