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M&A Stock Transaction - Termination of Target Plan


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Employer A and B are unrelated employers who both sponsor a 401(k) Plan.  Employer A purchases 100% of the stock of Employer B on December 15, 2017.  However, on December 14, 2017, Employer B establishes a termination date to terminate its plan as part of the M&A agreement because Employer A does not want to assume sponsorship of that plan.

ISSUE:  Employer A does not want to recognize prior service with Employer B (wishes to treat the newly acquired employees as new employees) requiring them to meet the age/service conditions in the plan to participate.

The excerpts below are from the ERISA Outline.  The first two seem to relate to an asset transaction (not stock transaction).  The third seems to back up that interpretation especially with the highlighted text.

  • IRC §414(a)(1) requires service for a "predecessor employer" to be treated as service for the current employer only if the current employer is maintaining the plan of the predecessor.
  •  IRC §414(a)(2) provides that where the employer does not maintain the plan of the predecessor employer, service with the predecessor employer does not have to be counted by the new employer, except to the extent provided in regulations. Since no regulations have been issued, the IRS has generally treated the granting of service under the circumstances described in IRC §414(a)(2) to be elective on the part of the employer, provided that the granting of service does not create prohibited discrimination.
  • According to the IRS in GCM 39824, an employee generally does not have a severance from employment merely because all or a portion of the stock of the company is sold to another person. For example, if the shareholders of a corporation sell their stock to another business, or to other individuals, the change of ownership of the corporation does not cause the employees of that corporation to have a severance from employment. This is true regardless of whether the corporation maintains a plan and, if it does, whether it continues to maintain that plan after the sale. The IRS is simply recognizing here that in a stock sale, the entity itself continues. Only the owners of that entity have changed. Thus, there is no “former” employer from which the employees of the entity can have a severance from employment.

When the employee is treated as having a severance from employment from the seller, the buyer does not have to give the employee credit for service with the prior employer.  If there is no severance from employment, then the employees are treated as continuing to work for the same employer.  

QUESTION:  Does the termination of Employer B's 401(k) plan prior to the acquisition date (12/15/2017) allow Employer A to treat the newly acquired employees as having a severance from employment and therefore no mandatory recognition of prior service is required?

I have always thought the answer was YES but I am beginning to second guess this answer.  Any feedback is greatly appreciated! Thank you.

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I believe that that if a buyer purchases 100% of seller's stock that employees haven't severed employment upon the sale.  Therefore, I believe recognition of all service prior to the sale is required (subject to certain plan provisions of recognizing prior service for vesting, etc. prior to the establishment of the plan).  I do not believe the termination of the plan prior to the acquisition date is relevant to recognition of prior service in this case.

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My apologies in advice for the lengthy post - but the info below is relevant to the exceptions.


In general, the acquisition of one organization by another unrelated organization through a stock acquisition is usually treated as a continuation of employment for all plan purposes.  But as in all general rules, there are exceptions.  I’ve been part of a few conversations with attorneys who felt the interpretation below (414(a))  is in line with the interpretation of Treas Reg 1.411(a)(5) where vesting is excluded for pre-affiliation, pre-effective date and if not a  predecessor employer.


Exception #1: Stock sale of a subsidiary or division of one company to another unrelated company/controlled group.  This will be treated as a severance of employment if the “3 part test is satisfied.” (see green highlighted excerpt from the EOB below)


Exception #2:  immediate liquidation of the acquisition following the stock sale or termination of the target plan before the stock purchase.  Per the EOB, this might be an aggressive approach but there are arguments presented that should be considered and the employer should make the final decision.  (see yellow highlighted excerpt from the EOB below).  IRC §414(a) is the IRC that I mentioned to you and it is discussed in yellow below.


Exception #3:  Successor Plan:  If it’s not a subsidiary sale, the issue of plan termination prior to the stock acquisition date also affects whether the buyer’s plan is considered a successor plan for distribution purposes.  (see blue highlights from the EOB below).  As long as the buyer doesn’t assume sponsorship or accept a transfer/spinoff of assets from the pre-sale plan the buyer’s plan shouldn’t be treated as a successor plan for distribution purposes (401k distribution restrictions) even if it is a stock sale.


2.c.2) Stock acquisitions. Where the new employer has acquired all or part of the stock (or other equity interest, in the case of a noncorporate entity, such as a partnership), the “new” employer (i.e., the buyer of the stock) is really the continuation of the “prior” employer (i.e., the seller of the stock). The employees in reality work for the same employer, it’s just that the owner (or controlling owner) of the employer has changed. Thus, the employees of the seller (or of the company owned by the seller) do not incur a severance from employment merely by reason of the stock sale. If this concept is applied to the crediting of service for eligibility purposes, whether a pre-acquisition plan is being continued shouldn’t really be a relevant concern, and the principles stated in 2.a. and 2.b. above are also not relevant. Thus, service with the “prior” employer must be credited, even if the “prior” employer did not maintain a plan at the time of the acquisition that is being continued by the “new” employer.

2.c.2)a) Sale of interest in a subsidiary. The IRS recognizes a severance from employment in one type of stock/equity transaction - - where a subsidiary of a parent company is sold to an unrelated parent company. Under these circumstances, the asset sale principles are applied (as if the ownership in the subsidiary is an asset of the selling parent company), as described in 2.c.1) above, in determining whether a severance from employment has occurred. See Notice 2002-4. If this concept is applied to the crediting of pre-acquisition service, prior service with the subsidiary is required to be credited only if the new parent company (or the acquired subsidiary) continues the subsidiary’s plan after the acquisition, as discussed in 2.a. above, rather than applying the default rule described in 2.c.2) above.



2.d.5) Example - immediate liquidation of acquired related group member or transfer of that company's employees to payroll of acquiring company. Suppose in the example in 2.d.3) above that, following the acquisition of W's stock, W is liquidated (or W is maintained as a shell corporation) and the employees of W are transferred to Q's payroll. In this case Q is the successor employer of the W employees. Normally, since this is a stock acquisition, pre-acquisition service with W would be recognized after the acquisition. However, if no plan was maintained by W (or W's plan was terminated before the acquisition of stock that resulted in a controlled group relationship between W and Q), it is arguably a reasonable interpretation of IRC §414(a) for Q not to credit service with W that was earned before Q acquired W, unless Q's plan was amended to provide for such service credits pursuant to IRC §414(a)(2) (similar to the rules described in the example in 2.d.1) above, which involved an asset acquisition). The idea here is that although Q acquired W’s stock, resulting in a controlled group relationship between Q and W immediately following the acquisition, W was not continued as a separate legal entity, so the transaction is more analogous to the asset acquisition example. If, however, W maintained a plan for its employees, and that plan is merged into Q's plan, Q's plan would be required to credit the pre-acquisition service with W for eligibility purposes, pursuant to IRC §414(a)(1), similar to the situation in the example in 2.d.2) regarding an asset acquisition and the takeover of the prior employer's plan.



5.e. Change of related group because of stock acquisitions. Where a company terminates a 401(k) plan, and the company’s stock is later acquired, does a successor plan issue arise if the acquired company later adopts a plan? This issue has been more problematic than the asset acquisition described in 5.d. above, because the entity whose stock has been purchased continues to exist. At numerous employee benefits conferences, IRS officials have stated that the Treasury intends the successor plan rule to apply the same way to asset and stock acquisition, so that the form of the sale is not driven by the plan issues. If a company’s stock is acquired in a manner that shifts the company from one related group to a different related group, the IRS has informally stated that, so long as the termination date of the plan (as determined under Rev. Rul. 89-87) is established before the stock acquisition, the “employer” that maintained the terminated plan is not the same as the “employer” that maintains the new plan. Therefore, the company’s participation in the plan of the new related group will not create a successor plan and the employees of the acquired company may have their 401(k) balances distributed from the terminated plan, pursuant to IRC §401(k)(10). This is consistent with IRS’ view of when a severance from employment occurs with respect to employees of a subsidiary that is sold to a different controlled group. See Notice 2002-4 and the discussion in 3.b.3)a) above. At the Q&A session with the IRS at the 2012 ASPPA Annual Conference, the IRS representatives on the panel agreed that, in the absence of formal guidance to the contrary, it would be reasonable to assume that the “employer” is determined at the time of the plan termination, and the stock acquisition would result in a new employer for successor plan purposes.

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I have not read all of the above, so may have misunderstood the question, but I think this issue has come up in this bulletin board several times with no definitive answer. The weight of authority seems to be that the acquirer can't ignore the service, because it was with a constituent entity (i.e., whether the acquired company is maintained as a sub or is merged into acquirer should get you same answer). Derrin Watson's "Who's the Employer" advocates this position, I believe. Others have pointed out that they received determination letters that say that service of controlled group members is only counted for the period during which the controlled group existed.

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