Company Acquisition

[KateSmithPA]

Company A incorporates in 2001. No employees. No plan.

In 2002, Company A buys Company B. Company B has an existing 401(k) plan which Company A adopts.

For 2002 adp/acp test - are employees who earned more than $85,000 in Company A in 2001 HCEs for the 2002 test?

If the plan uses prior year testing, do they have to use the results from Company A for 2001?

Thanks.

[Guest Luke Bailey]

I think you would look back to Company A's 2001 facts to determine whether Company A employees participating in the plan in 2002 are HCE's or NHCE's in 2002. It appears from your description that Company A is in existence in 2002 and 2001, and that it adopted the plan in 2002. (I say this because you arguably could get to a different result if, for example, B had acquired A in an asset acquisition. Then technically the old A employees would be 2002 Company B new hires, at least in form, but those are not your facts.) So I would say that individuals who were 5% owners of Company A in 2001 or 2002, or who made more than $85,000 from Company A in 2001 would be 2002 HCE's with respect to the plan.

As to whether you go with only the plan's 2001 Company B facts to determine the NHCE 2001 ADP to use in 2002 prior year testing, I think this depends on the rules of Section VI of IRS Notice 98-1. If the Company A NHCE's added to the plan in 2002 are 10% or less of the plan's 2002 HCE's, then you can disregard the NHCE's added to the plan in 2002 from Company A, and just go with the Company B 2001 NHCE ADP. However, if the Company A NHCE's added to the plan in 2002 exceed 10% of the plan's 2002 NHCE's, then I think you'd need to use a blended NHCE ADP for the two groups. Presumably, since the Company A NHCE's did not participate for 2001, you'd treat the plan as being in its first year as to them, and you'd use the 3% rule for the Company A NHCE group, or their actual 2002 ADP as their 2001 ADP.

Note that there really is no clear guidance on some aspects of these issues, and opinions may vary.

[KateSmithPA]

Thank you very much. I think these things get so confusing.

[Guest Luke Bailey]

You're quite welcome. Good luck. I should have added that the IRS has been working off and on on regulations covering these issues (i.e., 401(k) testing after mergers and acquisitions) for 15 years or so, and has now apparently back-burnered or abandoned the project (I think only back-burnered, because you can see some of their thinking in Notice 98-1, and I'm sure they'll ultimately want to give these rules the status of a regulation).

[david rigby]

Possibly relevant Q&A from the 2003 Gray Book:

"QUESTION 21

Nondiscrimination: Determination of Highly Compensated Employees After Acquisition

A client maintains a 401(k) plan. In 2002, they acquire a company through a stock purchase and brought new people into the plan. For the new people who just came in as a result of the acquisition, how do we determine if they are HCEs? Do we look at their compensation from the prior year even though they worked for someone else?

RESPONSE

Since this is a stock purchase, it would be reasonable to base the HCE determination on compensation with the purchased company. "

Note that other case (asset purchase) was intentionally not answered by the IRS representatives.

[Guest Luke Bailey]

Quite relevant, and the inferences that can be drawn from the Gray Book Q&A are, I think, consistent with what I suggested. (By the way, in rereading my response I realize that I accidentally left out my key assumption that this was a stock acquisition, which I assumed it to have been.) The way I've looked at this in the past, if two historically distinct employers end up in the same K plan through a stock acquisition, then they each bring their prior year facts with them for identifying HCE's. If there's an asset acquisition, then arguably the employees of the acquired entity are new hires with no prior year history. However, in the latter case, if the K plan that you're dealing with results from a merger of the acquiror's and acquired company's plans, it may be more difficult to argue that the acquired group consists of new hires with no prior year comp history.

By the way, what's the Gray Book? Is that the compilartion of government answers to questions posed by ABA or ASPA?

Thanks.

[david rigby]

Oops, just assumed that most readers were familiar with the Gray Book. It was initiated in 1990 as a way of asking the IRS, on an informal basis, certain questions that were not addressed in either regs or statute. It is co-ordinated by several actuaries, and distributed at the Enrolled Actuaries Meeting each year (usually in March), and at other professional meetings.

This is the caveat at the beginning of the Gray Book:

"Summary of Meeting between the Enrolled Actuaries Program Committee and Staff of the Treasury Department and Internal Revenue Service on January 23, 2003

The following pages set forth the questions posed to certain staff of the Treasury Department and the Internal Revenue Service at a meeting on January 23, 2003 with representatives of the Enrolled Actuaries Program Committee. Included also are summaries, prepared by the representatives of the Program Committee, of the oral responses to those questions, which represent only personal views of the individuals who responded. Because those oral responses do not result from the systematic legal and policy analysis, review and clearance involved in producing regulations and other administrative guidance on which taxpayers can rely, different responses may be given at other times or by other staff, and administrative guidance may be issued that is inconsistent with the oral responses. Accordingly, the responses do not necessarily represent the positions of the Treasury or the IRS and cannot be relied upon by any taxpayer for any purpose. "

Attendance at the EA meeting usually entitles one to a CD-ROM of that year's Q&A's.

Also, please note this copyright:

Copyright © 2003, Enrolled Actuaries Meeting

All rights reserved by Enrolled Actuaries Meeting. Permission is granted to print or otherwise reproduce a limited number of copies of the material on the diskette for personal, internal, classroom, or other instructional use, on the condition that the foregoing copyright notice is used so as to give reasonable notice of the copyright of the Enrolled Actuaries Meeting. This consent for free limited copying without prior consent of the Enrolled Actuaries Meeting does not extend to making copies for general distribution, for advertising or promotional purposes, for inclusion in new collective works, or for sale or resale.

[Guest Luke Bailey]

Thanks. The ABA does something similar, but I don't think they give the compilation a particular name. It's just referred to as the Q&A's for a particular year, I believe.