Business reorganizations can create significant complexities with the benefit plans of both the buyer and the seller. Among these complexities is how the parties should handle the health FSA of the selling organization.
As with most benefits issues related to mergers and acquisitions, the appropriate course of action generally depends on whether the transaction is an asset sale or stock sale. Very generally, a stock sale is when the buyer purchases all of the stock or other ownership interest in the seller’s business. An asset sale is when the buyer purchases all or specified assets (and any agreed upon liabilities) of the seller. In a stock sale, the purchased organization can continue to exist under new ownership, or it can merge into the buyer’s business and operations, in which case the purchased organization ceases to exist.
The IRS issued guidance here in the context of an asset sale, set forth more specifically below. Most commonly, however, we address these questions in the context of stock sales. While there is no formal guidance on FSAs in a stock sale, IRS officials have informally indicated that an FSA account balance transfer should be permissible in this situation. This would allow the employees of the acquired business into the buyer’s cafeteria plan midyear (at the time of the closing) with the same level of FSA coverage and the same salary reduction elections as they had under the seller’s cafeteria plan at the time of the sale. In this situation, the buyer has to make appropriate amendments to its plan. Note that where this approach is not taken, the ‘use it or lose it’ rules applies, with a run out period.
While an FSA is generally subject to COBRA (with some special rules), in a stock sale COBRA coverage is not required because there has been no termination of employment or other COBRA trigger. In the case of an asset sale, IRS Revenue Ruling 2002-32 provides the following two approved scenarios:
- Coverage Under Seller’s Health FSA With Salary Reductions Under Buyer’s Plan. In this scenario, during the plan year, an entity 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, e.g., 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 own health FSA for the remainder of the plan year. The employees’ account balances (whether underspent or overspent) under the seller’s health FSA are rolled over to the buyer’s health FSA. 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, and no midyear election change is permitted as a result of the asset sale.
Note that business reorganizations are as diverse as they are complex, and each one is unique. In addition, the buyer and seller can agree to different terms related to the FSA, and their benefit offerings in general, via the purchase agreement. Clients should work closely with counsel and their benefits broker as they address the benefits-related issues in business reorganizations.