THE LIFE OF A PLAN CASE STUDY Acquisitions. Charles D. Lockwood, J.D., L.LM ASC

Transcription

1 THE LIFE OF A PLAN CASE STUDY Acquisitions Charles D. Lockwood, J.D., L.LM ASC 1

2 Charles D. Lockwood, J.D., L.LM ASC Charles D. Lockwood, J.D., and LL.M. (Taxation), has over 20 years experience in the employee benefits field. Charles is currently a principal with the ASC Institute (ASCi). Prior to joining ASCi, Charles was a principal with the pension consulting firm Global Benefit Advisors, LLC (GBA). Prior to entering private consulting, Charles worked in the Employee Plans Division in the National Office of the Internal Revenue Service (IRS) as a Tax Law Specialist. Charles also was a Vice President with Pension Publications of Denver, Inc. (PPD) and a senior consultant with the benefit consulting practice of Coopers & Lybrand. 2

3 Case Study Assumptions 3 rd of a six part case study going through a sample life of a retirement plan (setup, testing, acquisition, corrections, cash balance and termination) The current IRS limits for 2016 will be used for all of the case study sessions Not focusing on the choice of investment provider or recordkeeper but will assume non-bundled TPA platform 3

4 The Initial Test Subject Sample Company, LLC LLC taxed as a partnership with husband and wife 50/50 members Started with a SIMPLE plan (match) because advisor buddy said it would be easy to have a plan with no costs Committed to the idea of having a plan Successful years prompt their CPA to encourage them to find a way to shelter more income from taxes 4

5 Plan Design Sample Company, LLC amended plan into safe harbor 401(k) plan with 3% SH nonelective contribution on a maybe notice Plan permits employees to make both pre-tax salary deferrals and Roth deferrals Plan also provides additional ER contribution that will be cross-tested with each participant in his/her own benefit group and no accrual requirements Eligibility will be 60 days/age 21/1 st of month entry on deferrals and 1 year/21/dual entry for ER contributions 2/20 vesting Age 59 ½ distributions, safe harbor hardship withdrawals and participant loans allowed 5

6 Sample Co. Census Eligible Comp Date of Birth 401(k) Deferrals Catch-Up Deferrals Safe Harbor 3% Employer Contribution Robert 246, /14/ , , , , Beverly 246, /6/ , , , , Jim (s) 70, /16/1984 7, , , Sara (d) 25, /24/ Eve 48, /13/1955 4, , Clara 55, /12/1981 3, , James 41, /16/ , Terry 10, /3/1974 1, Carrie 66, /27/1974 1, , , Sally 42, /7/ , Steve 40, /17/ , Kia 8, /2/ Alex 30, /9/ Mary 55, /4/ ,

7 Mergers and Acquisitions Among most complex areas of plan administration and compliance Many questions, few answers = waiting for IRS guidance Difficult testing issues can arise where you have a merger or acquisition Company transactions that can affect qualified plan Asset sale Stock sale Merger 7

8 Asset Sale Seller Assets EEs Buyer After sale Seller may continue to maintain plan or terminate plan Plan may be transferred to Buyer as part of sale Many times the plan is not considered in sales agreement 8

9 Stock Sale Parent P Sample Co. Subsidiary Y Subsidiary Y Subsidiary Y continues to exist after sale 9

10 List of Issues Crediting of service for eligibility/vesting Will new employees participate immediately in buyer s plan? Is a plan amendment needed to cover new employees immediately? Coverage / nondiscrimination testing Determining HCEs Plan contributions Plan distributions / successor plan Protected benefits Plan loans 10

11 Due Diligence Plan documents / interim amendments Summary plan description Favorable IRS letters Most recent Form 5500s Board Resolutions Participant notices Discrimination tests Contribution reports 11

12 Due Diligence Interests of buyer and seller are usually in conflict = Seller generally wants to limit responsibilities after sale Buyer may want Seller to retain responsibility for winding up existing plan and avoid liability for Seller s obligations Buyer may want Seller to warranty that: Seller has complied with ERISA, Code, and other laws No breaches of fiduciary duties or prohibited transactions All contributions (including deferrals) have been made to plan 12

13 Severance of Employment Many issues can be answered based on whether EEs have severance of employment Determination is based on whether EEs are still working for company maintaining plan If have severance of employment = treated as new EE Different analysis applies depending on whether sale is asset sale or stock sale Need to know what will happen to plan after acquisition 13

14 Severance of Employment = Asset Sale What will happen to plan after acquisition? Seller retains plan or Seller has no plan Buyer maintains Seller s plan o May want to include in purchase agreement that Seller remains liable for any qualification failures o Purchase agreement should cover division of responsibilities regarding contributions and reporting requirements Plan merger o Merged plan would take on any taint from prior plan Plan termination o Seller may terminate plan before or after acquisition o Termination creates distribution options for participants 14

15 Severance of Employment = Asset Sale If Seller retains plan after sale or has no plan = severance of employment Buyer is treated as new ER and EEs who go to work for Buyer are treated as new EEs If Buyer takes over sponsorship of plan or merges Seller s plan into Buyer s plan EEs who go to work for Buyer do not have severance from employment Buyer is treated as same ER with respect to Seller s EEs who are transferred to Buyer 15

16 Severance of Employment = Stock Sale Since EEs continue to work for same ER after sale (only change in controlled group) = no severance of employment Generally, plan will continue to be maintained by sold company since continues after sale = EEs do not have severance of employment even though in new controlled group Exception applies if purchase subsidiary of parent and parent maintains plan before and after sale Parent P ER X Sub Y plan Sub Y 16

17 Severance of Employment = Stock Sale Since EEs continue to work for same ER after sale (only change in controlled group) = no severance of employment Generally, plan will continue to be maintained by sold company since continues after sale = EEs do not have severance of employment even though in new controlled group Exception applies if purchase subsidiary of parent and parent maintains plan before and after sale Parent P plan ER X Sub Y Sub Y 17

18 Case Study Effective March 1, 2016, Sample acquires ABC Co. ABC maintains a traditional 401(k) plan that provides for matching contributions and deferrals. Fact Pattern #1 = Sample buys the assets of ABC. ABC retains the plan after the sale (or has no plan) Fact Pattern #2 = Sample buys the assets of ABC. Sample takes over the plan of ABC after the sale Fact Pattern #3 = Sample buys the stock of ABC. ABC continues to maintain the plan after the sale Fact Pattern #4 = Sample buys the stock of ABC. ABC does not maintain plan 18

19 ABC Co. Census Eligible Comp Date of Birth 401(k) Deferrals Catch-Up Deferrals Match Bill 265, /1/ , , , Dawn 265, /9/ , , , Joe 250, /8/ , , Sally 200, /10/ , , Bob 60, /16/1984 6, , Mary 50, /24/ Claire 48, /13/1965 4, , John 45, /12/1981 2, , Laura 41, /13/ Flo 10, /3/

20 Eligibility to Participate When are ABC EEs eligible to participate under the Sample plan? Crediting service with prior ER is mandatory if maintaining plan of predecessor ER = no severance of employment o Plan should be drafted to automatically count service Crediting service with prior ER is voluntary if not maintaining plan of predecessor ER = severance of employment o Plan amendment may be required for EEs to begin participating in Buyer s plan 20

21 Eligibility to Participate Fact Pattern #1 = Asset sale, ABC retains plan Service with ABC does not count under Sample plan = severance of employment Sample needs to make decision whether they want to cover ABC s EEs o If they want to cover ABC EEs immediately i.e., give credit for service with ABC = should amend plan before transaction to allow EEs to begin deferring immediately in Sample plan o If they want to exclude ABC EEs completely = would need to amend plan Some plans provide for exclusion of EEs in Code 410(b)(6)(C) transaction = may require plan amendment if want to cover those EEs 21

22 Eligibility to Participate Fact Pattern #2 = Asset sale, Sample takes over ABC plan Service with ABC counts under Sample plan If Sample will be maintaining separate plans, Sample should amend both plans to exclude EEs not covered in each plan o Should amend plans before sale occurs If merging plans together or transferring assets into Sample plan, ABC EEs will automatically receive credit for service with ABC = no amendment required 22

23 Eligibility to Participate Fact Pattern #3 = Stock sale, ABC continues plan No severance of employment since EEs continue to work for company maintaining plan Do ABC EEs participate in Sample plan? o Depends on plan design = many plans require controlled group members to adopt plan o Some plans cover all EEs of controlled group = would need to amend plans to cover appropriate EEs Need to make decision how going to maintain plans after sale o If separate plans for each entity = make sure no duplicate coverage o If going to merge plans = can do so within transition period without having to run coverage test o If going to terminate Seller plan = may want to do so before sale occurs to allow for distribution of deferrals 23

24 Eligibility to Participate Fact Pattern #4 = Stock sale, ABC does not have plan No clear guidance regarding crediting of service. One argument = count service with ABC since no severance of employment because working for same company after sale Alternative argument = do not count service with ABC since not still working for company maintaining plan have severance of employment o Hard to argue since EEs are still working at same company/job after sale 24

25 Vesting Vesting Is any additional vesting required as result of sale of company? Fact Pattern #1 = Asset sale, ABC retains plan o EEs have severance of employment but no additional vesting required (unless ER terminated plan) o Be careful if have a partial termination that requires full vesting of all affected participants o Sample needs to amend its plan if it wants to credit service with ABC Fact Pattern #2 = Asset sale, Sample takes over plan of ABC o No severance of employment so no additional vesting o Sample must credit service for vesting under its plan Fact Pattern #3 / #4 = Stock sale o No severance of employment so no additional vesting 25

26 Coverage/Nondiscrimination Testing How are Sample and ABC plans tested for coverage and nondiscrimination after acquisition? Special transition rule applies when there is a change in related group due to an acquisition or disposition o If plan satisfies coverage at the time of acquisition or disposition = deemed to pass coverage during the transition period Transition period - year of transaction and following plan year Cannot be substantial change in plan coverage (other than direct result of merger/acquisition) o Can plan be amended after acquisition without eliminating transition period 26

27 Example Sample Company 2 HCEs, 12 NHCEs (3% SH contribution) ABC Company 4 HCEs, 6 NHCEs (Match / deferrals) Effective January 1, 2016, Sample Company purchases ABC Company. ABC Company maintains a traditional 401(k) plan that provides for matching contributions and deferrals. Do plans satisfy coverage / nondiscrimination? Fact Pattern #1 = Asset sale, ABC retains plan o Plans are deemed to satisfy coverage during transition period o Transition period applies for 2016 and 2017 plan year o Sample Plan deemed to satisfy coverage during transition period. Presumably could amend plan to include ABC EEs. Plan satisfies SH requirements 27

28 Example Sample Company 2 HCEs, 12 NHCEs (3% SH contribution) Effective January 1, 2016, Sample Company purchases ABC Company. ABC Company maintains a traditional 401(k) plan that provides for matching contributions and deferrals. Do plans satisfy coverage / nondiscrimination? Fact Pattern #2 = Asset sale, Sample takes over plan of ABC o Both plans deemed to satisfy coverage during transition period. Each plan tested separately for nondiscrimination. Presumably could amend plan to exclude EEs under other plan. Sample plan satisfies SH requirements and separate ACP for ABC. Fact Pattern #3 = Stock sale o Same as Fact Pattern #2 ABC Company 4 HCEs, 6 NHCEs (Match / deferrals) 28

29 Example Sample Company 2 HCEs, 12 NHCEs (3% SH contribution) ABC Company 4 HCEs, 6 NHCEs (Match / deferrals) Effective January 1, 2016, Sample Company purchases ABC Company. ABC Company maintains a traditional 401(k) plan that provides for matching contributions and deferrals. Do plans satisfy coverage in 2018 (assuming no change in census of either company? Sample plan (ER contributions / deferrals) = 12/18 (66.67%) / 2/6 (33.33%) = 200% (passes) ABC plan (match/deferrals) = 6/18 NHCEs (33.33%) / 4/6 HCEs (66.67%) = 50% (fails ratio test) 29

30 Example Sample Company 2 HCEs, 12 NHCEs (3% SH contribution) ABC Company 4 HCEs, 6 NHCEs (Match / deferrals) Do plans satisfy coverage in 2018 (assuming no change in census of either company? If ER maintains more than one plan may test each plan separately for coverage and nondiscrimination o If satisfy coverage separately = must run separate 401(a)(4) tests May permissively aggregate plans = if aggregate for coverage must aggregate for nondiscrimination o May only permissively aggregate if plans are using same plan year o Can only permissively aggregate qualified plans = cannot aggregate SH 401(k) plan with non-sh 401(k) plan 30

31 Example Sample Company 2 HCEs, 12 NHCEs (3% SH contribution) ABC Company 4 HCEs, 6 NHCEs (Match / deferrals) If both plans satisfy coverage can test plans separately for nondiscrimination Why is that important? Can test plans separately = Sample Co will be able to satisfy SH requirements Do not have to worry about different benefits, rights and features If necessary can run average benefits test to demonstrate separate plans satisfy coverage 31

32 Merger of Plans If ER decides to merge plans = special issues can occur, especially if merger occurs mid-year Timing of deferrals = when will Seller EEs begin participating in Buyers plan How will Buyer enroll Seller EEs in Buyer plan o What will happen if cannot enroll Seller EEs right away? If merge plans = lose transition rule? Can run coverage / nondiscrimination tests as if one, two or three plans in year of merger How are plans tested for coverage/nondiscrimination if plans merged during plan year? 32

33 Merged Plans Plan 1 Plan 2 Plan 1 & 2 Plans are merged on October 1, How should plans be tested for nondiscrimination? 33

34 Merged Plans Plan 1 Plan 2 Plan 1 & 2 Plans are merged on October 1, How should plans be tested for nondiscrimination? 34

35 Merged Plans Plan 1 Plan 2 Plan 1 & 2 Plans are merged on October 1, How should plans be tested for nondiscrimination? 35

36 Merged Plans Plan 1 Plan 2 Plan 1 & 2 Plans are merged on October 1, How should plans be tested for nondiscrimination? 36

37 Merged Plans Plan 1 Plan 2 Plan 1 & 2 What if plans are on different fiscal years (e.g., Plan 1 is October 1 and Plan 2 is December 31 year end)? New plan will use December 31 year end. 37

38 Merged Plans Plan 1 Plan 2 Plan 1 & 2 What if plans are on different fiscal years (e.g., Plan 1 is October 1 and Plan 2 is December 31 year end)? New plan will use December 31 year end. 38

39 Merged Plans Assume Sample merges plans effective January 1, 2016 and runs ADP test using prior year testing. How is ADP test performed? Coverage change which results in more than one prior year subgroup = must use weighted average of NHCE ADP for prior year How would answer change if instead of a merger = plan is spun-off from prior plan? 39

40 ADP Test = Weighted Average Applies when using prior year testing and have coverage change during year resulting in more than one prior year subgroup NHCE ADP = Sum of adjusted NHCE ADPs Adjusted NHCE ADPs = NHCE ADP x NHCEs in prior year subgroup _ total NHCEs in all prior year subgroups Gives greater weight to ADP of plan with more NHCEs 40

41 Coverage / Nondiscrimination Seller plan covered 100 NHCEs. The ADP of the NHCEs for the prior year was 3.3%. Buyer plan covered 200 NHCEs. The ADP of the NHCEs for the prior year was 2.7%. The adjusted NHCE ADP for Seller plan is 3.3% x 100/300 = 1.1%. The adjusted NHCE ADP for Buyer plan is 2.7% x 200/300 = 1.8%. The weighted average for the merged plan is 1.1% + 1.8% = 2.9%. 41

42 Coverage / Nondiscrimination How do rules apply if plan is spun-off into separate plans? Transferor plan would still perform ADP/ACP test separately for period prior to spin-off o If using prior year testing = since only have one prior year sub-group = would use prior year ADP/ACP results for entire year Transferee plan runs ADP/ACP test from spin-off date o If transferee plan is an existing plan = would be treated in same fashion as merger of plans o Transferee plan could run 1, 2 or 3 tests If plans are eligible for permissive aggregation = could treat as single plan for testing purposes 42

43 Determination of HCEs Sample acquires ABC on 10/1/16. Sally earned $200,000 in 2015 and $105,000 from 1/1/16 9/30/16 from ABC. Sally earns $40,000 with Sample from 10/1/16-12/31/16. For 2016 is Sally an HCE of Sample if: ABC retains the plan after the sale Sample takes over the ABC plan as a separate plan or merges the plans What about for 2017? What if Sample buys the stock of Seller? 43

44 Determination of HCEs ABC Co. Assets EEs Sample Co. $180,000 = 2015 $105,000 = 2016 $40,000 =

45 Plan Contribution Suppose Sample purchases ABC Co on 10/1/16. Bob deferred $6,000 into the ABC 401(k) plan. ABC plan contains a last day requirement to receive the matching contribution under the plan. Is Bob entitled to a contribution under ABC plan? Fact Pattern #1 = Asset sale, ABC retains plan o No right to contribution because Jim has severance of employment before last day of plan year o Could Buyer make contribution for Seller EEs in Buyer plan? Fact Pattern #2 = Asset sale, Sample takes over ABC plan o Jim entitled to contribution unless ABC amends plan to eliminate contribution before end of year o Need to address contribution under buy-sell agreement o Fact Pattern #3 = Stock sale 45

46 Distribution Restrictions Distribution restrictions follow merged assets Difference between merger and rollover Be careful if have MP assets in Seller s plan Distribution may not be made from terminated 401(k) plan if ER maintains a successor plan Successor plan is any other plan maintained by ER within 12 months of final distribution of plan assets May need to terminate plan before sale to permit distribution 46

47 Example = Distributions Assume after the sale, ABC stays in business and continues to maintain the plan. May the EEs now working for ABC take a distribution from the ABC plan and rollover to Sample plan? Yes, EEs have severance of employment Would answer change if Sample took over maintenance of ABC plan? No severance of employment = may take in-service distribution, if allowed 47

48 Example = Distributions Sample purchases ABC in stock sale on 7/1/2016. Sample does not want to merge plans due to concerns over possible qualification issues. May Sample terminate plan on 7/2/2016 and distribute to participants? No, there is a successor plan Sample may not distribute deferrals upon plan termination since maintains another plan Will have to continue ABC plan, freeze ABC plan or merge plans together What should Sample and ABC have done? 48

49 Termination of Seller Plan If have stock sale and do not wish to merge plans = must terminate Seller s plan before transaction Even though EEs work for same company = IRS allows distribution since were in different control group at time of termination Suppose ABC plan was terminated on 6/25/2016 = may distribution still be made on 9/1/2016, after sale has occurred? If do not terminate before sale = can maintain ABC plan as frozen plan Make sure plan is amended to freeze benefits Amend Buyer s plan to cover EEs of Seller 49

50 Protected Benefits Plans generally cannot be amended to retroactively eliminate optional forms of benefit Plans may be amended to prospectively eliminate benefits Participants do not accrue right to benefits until they have satisfied any allocation conditions on such benefits If merging plans -- must protect optional forms under prior plan IRS regulations permit retroactive elimination of installments and annuity payments 50

51 Plan Loans Plan loans may become immediately due and payable if EEs have severance of employment EEs may be allowed to transfer loans to Buyer s plan in direct rollover EEs may be able to use bridge loan 51