After the acquisition: HR integration issues for tax

Importance of addressing HR issues after the acquisitionHR issues are not an add-on in an acquisition, but often central to the deal’s value. Especially in a service economy, the acquisition may be intended to acquire the value of the people who are the key contributors. In addition, compensation payments may be the single-largest transaction expense incurred at closing. If you don’t take steps to retain, reward and attract key employees, you may not get what you intended from your investment.

HR policies and procedures strongly affect people. If you do things employees don’t like ― and change what they do like ― you risk losing those employees whom it’s most important to retain and having a hard time replacing them.

A Grant Thornton LLP webcast, “After the acquisition: Critical actions for tax departments,” covered HR matters and a number of other issues related to tax department involvement after an acquisition. View the full archived webcast.

HR integration presents an opportunity to increase efficiency and reduce risk. It also offers a chance to streamline, if, for example, the acquirer is more centralized than the target.

Key questions to get started
  • Should you centralize or decentralize HR administration?
  • Should you migrate new employees onto the existing payroll system?
  • How should you handle the performance measurement process?
  • Are similar jobs paid differently between the two groups, and how do you resolve such issues?
  • How do you handle onboarding, recordkeeping, leave administration, the Equal Employment Opportunity Commission, the Family and Medical Leave Act, and similar issues?

You should know that generally the more employees you have, the better the pricing you get on benefit plans such as 401(k) retirement plans and health insurance. If you have 1,000 employees and you acquire a company with 500 employees ― substantially increasing the size of your plans ― you may be able to negotiate better deals from current vendors. It may make sense to put everybody together under a single plan. At the same time, this is an opportunity to identify and resolve compliance gaps and structural risks ― the sooner the better.

Retirement plans
A retirement plan integration discussion should consider the impact of the controlled group coverage testing rules, and here is why: When a target is acquired in a stock sale, the target enters the buyer’s controlled group for most tax purposes, including qualified retirement plans. (See Section 1563 definitions.) When this occurs, the buyer has several options. One alternative may be to operate different plans for different groups ― each group may be wedded to its own 401(k) plan, for example ― but this option can lead to higher administrative overhead for compliance testing and may also require corrective contributions to one plan or the other. When you operate multiple plans as described here, every year you will have to go through what many describe as a fairly painful meeting with vendors, law firms, etc., on whether you meet these controlled group coverage rules. Get a detailed discussion of the controlled group coverage rules.

Alternatively, you may elect to merge the target’s plan into the buyer’s plan, which may eliminate the need for controlled group coverage testing. Yet bear in mind that if the target’s plan has a qualification defect, those problems may “taint” the buyer’s plan as liabilities for qualification issues follow the target plan’s assets into the buyer’s plan.

Another alternative is to freeze the target’s plan. This does not involve transferring that plan’s assets into the buyer’s plan and isolates any issues or problems that may have occurred in the target plan prior to the closing. While a frozen plan will shrink over time (there are no new benefit accruals in a frozen plan), it may take some years for the plan to be paid out. This results in continued administrative overhead expenses (plan audits, annual filings, etc.) until the plan wears away over time.

If you time it right, terminating and paying out the target’s plan may be the simplest alternative. The key to making this work is for the target employer to adopt a resolution terminating the target plan prior to closing. When this is done, the plan may then be paid out (post-closing) to the participants while at the same time allowing those participants to immediately participate in the buyer’s plan. However, if the target plan is not formally terminated prior to closing, the buyer may run afoul of the “successor plan rules,” which essentially say that if an employer terminates one 401(k) plan, the employees cannot participate in another defined contribution plan of the same employer for 12 months.

The impact on health and welfare benefit plans
The post-closing cost of such benefits as health, life and disability coverage may go down because your covered group got bigger, or may go up because of changes in employee demographics. If the average age of employees in a company is 30 to 35, for example, you probably have a pretty good health claims history, and that claims experience is often reflected in coverage premiums. However, if you acquire a company where the average age is 50, those employees probably make more health insurance claims, and that blends in to create a higher benefit claims history. Most insurance companies (or self-insured plan actuaries) react pretty quickly to raise premiums when the plan’s loss experience degrades. A similar result can occur with workers’ compensation ― for example, if you bring people in a high-risk profession (workers in heavy industry, drivers, etc.) into your pre-existing group of office workers.

Rationalizing differences in predecessor benefit programs
The two companies may have had different policies for long-term disability, group life, pretax payment of parking expenses, etc. The same may be true of fringe benefits, employee discounts and so on. These types of items may be more important than you think. They are not balance sheet items, per se, unless you remember that employees value these benefits and perks as part of their culture, and that employee satisfaction with the culture can directly affect the balance sheet.

Integrating compensation programs
Compensation is the most sensitive HR issue of all. Properly pricing jobs is crucial. Is everybody with the same job description at the buyer and the target paid the same? Probably not. The salary history at the two companies may differ greatly. You must address whether these differences are reasonable and defensible or need to be adjusted, whether job descriptions can be merged, whether pay is enough to retain people, and whether to reconcile differences in the mix between performance compensation and fixed compensation.

Executive compensation
Executive compensation often is the most crucial and complicated compensation issue, and has the most tax implications as well. Often the executives of a company are why you bought it, whether they are doctors inventing something new or someone with a great business model. It is extremely important to align the compensation of the C-suite executives with the goals the combined organization now has for them.

Items to consider:
  • Is there a mix of fixed or performance-based compensation? Does one CEO get a large salary no matter how good a year the company had while the other CEO does not?
  • Equity compensation: Which executives should get stock options or other equity compensation?
  • Long-term compensation plans: What was in place before and do you change that? Do you put money aside for an executive who receives it only if the company hits targets by a certain date, or might the executive be uncomfortable with this level of personal risk?

Deferred and equity compensation
Executives of the seller may retain prior deferred compensation arrangements or enter into yours. In the case of a stock sale, existing deferred compensation arrangements, like any other liability, are assumed by the buyer. You should consider in advance whether the terms of the pre-existing arrangements (performance-based vs. guaranteed payments, length of vesting service required, etc.) still align the executives with the new environment, whether bringing them into the buyer’s programs is better or whether something new should be designed to reward the behaviors and results now desired.

Equity compensation arrangements (such as stock options) often are rolled over into equivalent grants of buyer’s stock. However, this increases the risk of operational errors, because complex Section 409A rules must be followed. If you make an error, the affected executives have to pay immediate income tax and an additional 20% surcharge income tax. There is no additional tax for the employer, but you would have angered the most important people in your company.

But properly handled rollovers of existing arrangements can keep executives aligned with the desire to increase the value of the underlying stock. Cashing out what they already had at closing lets them take “money off the table” and may require new grants to keep part of their compensation tied to the value of stock.

Prepare for the ACA
The Affordable Care Act (ACA) establishes a regime of very expensive penalties for noncompliance and presents what may be the largest-ever excise tax issues, combined with a lack of experience as to how this is going to play out. (2015 is the first year in which several of the penalties go into effect and another goes into effect in 2018.) Evidence suggests many companies are not prepared to follow the mandates of the ACA, and buyers should pay special attention during both the due diligence and integration phases to avoid unexpected liabilities. Nearly half of participants in the recent Grant Thornton LLP webcast from which this article was drawn said they are not sure how prepared their companies are to deal with the ACA. Educate yourself on the complicated details of the ACA and what it means for employers.

Section 280G: Golden parachute payments
Golden parachute payments may be very expensive to both the employee and the employer: The employee pays 20% additional tax (over and above regular income tax) on “excess” parachute payments, and the employer cannot deduct payments considered excess payments under the relevant rules.

Numerous types of payments are included in these calculations: deal bonuses, severance pay, accelerated vesting and payout provisions, and grants within 12 months of the transaction closing.

The key is to figure out in advance how much compensation is subject to the Section 280G rules. Public companies need to know about the lost deduction and reporting requirements. Private companies need to properly calculate and disclose the amounts involved to have a shareholder vote to approve the payments and avoid adverse consequences. If 75% of shareholders approve, you’re OK.

Be diligent as you review any golden parachute agreements. It can be even more expensive for an employer to pick up an executive agreement that says it will pay gross-up amounts for the additional tax on excess parachute payments ― i.e., the paying party will “gross up” the payment so the payee receives the original amount, net of the additional 20% tax. (Under the relevant rules, the gross-up payment is itself an excess parachute payment, so there’s income tax and the additional 20% tax on the gross-up payment, which must be grossed up, and so on.)

Post-closing compensation deductions
If you have a nonqualified deferred compensation plan and pay out on the day of closing ― say in June 2015 ― it’s not deductible until December 2015. Section 404(a)(5) says that the payment of deferred compensation is deductible in the employer’s taxable year in which the employee’s tax year ends. Because individuals are calendar-year taxpayers, this means that your deduction occurs in your taxable year, which includes Dec. 31 of the year the employee was paid. Note that restricted stock deductions have the same rule. On a typical timeline, this usually means that the buyer gets the deduction. If the target is not in existence on Dec. 31, 2015, it’s possible that no one gets the deduction.

Holdbacks/escrow amounts are not taxable to the employee until they are received; therefore they are not deductible until that date. Again, the buyer will usually get the deduction under this timing rule.

Payroll tax mitigation
The general rule is that the Federal Insurance Contributions Act (FICA) wage base is reset to zero when employees join a new employer. Because of this rule, FICA is often overpaid for employees for the year in which they change employers. While the employees’ share of the overpayment will be corrected in their Form 1040 returns, the employers involved are not entitled to a refund of their portion of the overpayment.

There is an important exception to this rule that applies when substantially all assets are acquired by a buyer — the buyer in those circumstances may be treated as a “successor employer” and is permitted to carry over compensation already paid by the target against the wage base the buyer applies in computing ongoing FICA obligations. Many payroll providers are slow to point out the applicability of this exception, so inquire proactively to determine whether you can take advantage of this rule.

See a case-study discussion of how this rule works.

Moving forward
Harmonizing HR processes and controls following an acquisition is critical to an integrated approach that accomplishes all the tax-related tasks that need to happen in the months after the transaction closes. Because the employees are often the key to realizing the value of an acquisition, getting all of this right is critical not just from a cultural standpoint but in terms of ROI from the deal.


Mark Ritter
+1 404 704 0114

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