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Stock Acquisition - Aligning HCE Definition

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I have had no luck finding a clear answer so hopefully someone here can help.  Straight-forward stock acquisition - Company A acquired Company B on 2/1/2020 and they each maintain their own 401(k) plans.  Company A 401(k) uses the top-paid group election for the HCE definition while the Company B 401(k) does not.  I know plans within a control group must have the same HCE definition, but does the 410(b)(6)(c) transition period apply to making the HCE definitions identical?

These plans use compliance services from a mutual fund company.  The mutual fund company is telling them they must align the HCE definition in 2020 and amend one of the two plans.  I disagree and have always been very conservative when it comes to the "no significant change in the plan" part of 410(b)(6)(c).  Is there something that states the HCE definition must align immediately and am I being too conservative in my hesitation to amend plans during the transition period?

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My interpretation of the transition rule is that you leave each plan alone in order to utilize the transition period. If you amend the plan to change the definition of HCE, I do think it eliminates the protection. Perhaps I'm too conservative on this as well, but I think the mutual fund company is wrong.

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Fully agree with you both and here's an example of why our interpretations make sense compared to the alternative view. What if the 401(k) plans are both safe harbor and what if one or both exclude HCEs from the safe harbor? Not even considering the transition rules concerning amendment, if you amend a safe harbor plan mid-year to change who is and is not an HCE and thereby also change, mid-year, who gets and does not get the safe harbor, I think you have a big problem. 

I believe the transition rules were designed so that for a brief time after a merger (1+ PY) that plans of merged entities could continue to fully operate on an "as is" basis (so no "change" amendments) and have time to iron out the logistical details regarding future compliance of the respective plans. These rules are there to help ease the problems of dealing with plan differences, not exacerbate them! Otherwise, WTF bother with the transition rules at all?

IHMO

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Hi, all --

 

There is no clear guidance from the IRS or Treasury about how to determine HCEs in the year of a stock acquisition or a business merger.  If you look at the Code and regulations, the clear intent of the rules was that there would be one applicable determination of who is an HCE and then that would apply across all plans.  But, in a stock acquisition, particularly where the acquired company and the buyer each sponsors its own plan and the plans will operate separately during the transition period, it is not clear at all how to determine HCEs.  So, I think it makes the most sense, and is defensible as a reasonable interpretation of the law, that you maintain the pre-existing HCEs from before the acquisition vis-a-vis each plan for the year of the acquisition.

 

A couple of additional notes:  first, the transition rules take you out of coverage testing, which relieves you of needing to define HCEs for that purpose.  But, the transition rule does not relieve you of nondiscrimination testing.  If your two 401(k) plans are just that, then you can go ahead and test them separately and the use of the prior HCEs in the year of transition probably makes the nondiscrimination testing harder to pass than if you had some kind of cross-company definition of HCE (i.e., there is some possibilty that people who were HCEs in the acquired company would become NHCEs due to the top 20% rule or something similar).  HOWEVER, remember that, if any of the plans use cross-testing and you use the average benefit percentage test as part of the cross-testing, then you need to take into account benefits of all plans of the company ... which means that the definition of HCE becomes problematic from that standpoint.  So, you may need to look at this a little differently in that circumstance.

 

Last but not least, look for situations in which any of the assumptions about what the rules might be if the IRS/Treasury actually wrote them creates a skewed result which is abusive in nature.  So, let's say that you make a reasonable assumption about who the HCEs are, and it turns out that, with that reasonable assumption, the amount that the HCEs get or can contribute quadruples from prior years.  Just be careful that you are not creating a situation where the IRS would be tempted to exercise its rights under the coverage and nondiscrimination rules to consider something abusive and plan-disqualifying.

 

Hope this helps.

 

Everyone stay healthy!

 

Ilene

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Thank you everyone for the input.  It is comforting to know others have the same opinion even if the IRS guidance is lacking (surprise!)  I think all of the points being made are spot-on and I'm stealing all of it for my response to the mutual fund company 😁

I hope everyone weathers this storm and stays healthy!

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