Summary

In Notice 2014-49, the Internal Revenue Service (“Service”) issued guidance on how to avoid potential penalties under the Affordable Care Act (“ACA”) in connection with mergers and acquisitions (“M&A”). The notice provides a “safe harbor” that M&A Buyers can use to count the hours of Targets’ employees hired by Buyer, if Buyer counts hours differently from the way Target counts hours.

Background on ACA Penalties

Under the ACA, large employers (i.e., companies with 100 or more full-time equivalents in 2015; 50 or more in 2016) must offer health insurance to substantially all of their full-time employees (70 percent of all full time employees in 2015 and 95 percent in 2016) or pay the Service a penalty (called an “assessable payment”) for each month they fail to do so. The potential monthly penalty is equal to (1) the excess of the number of the employer’s full-time employees over 30 (over 80 in 2015) multiplied by (2) $166.67 (hereafter, the “A” penalty).

If a large employer offers health insurance to its full-time employees, but the insurance either is unaffordable or does not provide minimum value, the employer must pay an assessable payment to the Service if a full-time employee obtains a tax subsidy on an ACA Exchange. Under this rule, the potential penalty for each month is equal to (1) the number of full-time employees who receive such a subsidy multiplied by (2) $250.00 (hereafter, the “B” penalty), but never more than the “A” penalty.

The maximum monthly penalty is equal to the number of the employer’s full-time employees minus 30 (minus 80 in 2015) multiplied by $166.67. Under Code § 275(a)(6), neither the A penalty nor the B penalty is tax deductible.

ACA Potential Impact on M&A

The ACA can impact M&A in at least two ways.

First, in a stock deal, Buyer will assume any unpaid ACA penalties owed by Target. Although this is generally true for any taxes or other liabilities assumed in a stock deal, there may be some differences. One potential difference is the ACA penalties are not due until the Service issues a notice and demand. Thus, for cash basis taxpayers, the ACA penalty will not be reflected on Target’s financial statements (unless Target received a notice and demand in the same year as the deal). For accrual basis taxpayers, any “A” penalty owed should be recorded as a federal tax payable, whether or not the Service has assessed Target with a notice and demand. However, according to David Evangelista, Principal at MSPC Certified Public Accountants and Advisors, PC in New Jersey and New York, “any potential ‘B’ penalty liability is not estimable (unknown until notified by the Service) and generally would not be recognized in Target’s financial statements prior to the receipt of a notification from the Service, whether or not Target operates on a cash basis or accrual basis method of accounting.” Moreover, the Service might not assess a “B” penalty for two or more years after the deal closes. Note, however, that in many cases the “B” penalty may not be considered material.

Second, whether or not Target is acquired in a stock sale or asset sale, if Buyer hires Target’s employees, any such acquired employees who are “full-time” must be offered health insurance that provides minimum value and is affordable if Buyer wants to avoid potential ACA penalties. Liability for the potential penalties would generally accrue post-closing, and would generally not be imposed on Target pre-closing (even though the liability could result, at least in part, for services the acquired employees performed for Target pre-closing).

Safe Harbor to Identify Which Acquired Employees are Full-Time

To measure which employees are “full-time,” many employers average employees’ hours over a period of several months. This is referred to as the “look-back measurement method.” The term “measurement period” is used to identify the months over which employees’ hours are averaged.  Employees who average 130 hours per month during the look-back measurement period are considered “full-time” for purposes of the ACA for the duration of a predetermined period, known as “stability period,” that follows the measurement period. For example, an employer may average employees’ hours over a nine-month measurement period that runs from January 1 to October 30, and use a nine-month stability period that follows the measurement period. Under the look-back measurement method, employees who average 130 hours per month during the January 1 to October 30 measurement period would have to be treated as full-time for the following nine-month stability period – which in this example would run from November 1 to the following July 31 – even if their hours were to fall below 130 per month during that stability period.

Subject to certain requirements, an employer can use different measurement periods and different stability periods for different categories of employees. However, the employer may only differentiate among the following permissible employee categories: (1) union employees and non-union employees; (2) each group of union employees covered by a separate collective bargaining agreement; (3) salaried employees and hourly employees; and (4) employees employed in different states. This means, among other things, that employers must use the same measurement periods and stability periods for every employee within each of these categories. A violation of this rule would be an impermissible categorization of employees.

When measuring whether the acquired employees are considered full-time, Buyer is required to take into account the hours credited to the employees for services performed for Target pre-closing. A problem can arise if Buyer and Target use different look-back months, with either different start dates or different durations, to measure employees’ hours.

The new guidance from the Service provides “safe harbor” methods for coordinating different look-back measurement periods used by Buyer and Target in various circumstances. The guidance can be considered a “safe harbor” because the Service has said that companies may, in connection with corporate transactions in which employers use different measurement methods, rely on the approach described in Notice 2014-49 until further guidance is issued, and in any case until December 31, 2016.

The guidance applies different rules to different situations, but the general rule is that an employee who is in a stability period at the time of the M&A must retain his or her status (as either full-time or not full-time) at least through the end of that stability period (though an employer can always offer insurance to employees who are not full-time). For an employee who is not in a stability period at the time of the M&A, the employee’s status is determined using the look-back measurement method applicable to the employee’s position with Buyer, but including all hours of service credited to the employee while working for Target in applying that measurement method. To give one example, assume that Target merges into Buyer on April 1, 2017. Also assume that Target measures average hours credited during the calendar year (January 1 to December 31), and those employees who average 130 hours per month for the year are treated as “full-time” for a stability period that lasts for the duration of the following calendar year. Assume further that Buyer averages hours using six-month periods that run from April 1 to September 30 and October 1 to March 31, and treats employees who average 130 hours over a six-month measurement period as full-time for a subsequent six-month stability period. Under the safe harbor guidance, those employees whom Target would, but for the merger, treat as full-time from January 1, 2017 to December 31, 2017 (i.e., those employees who averaged 130 hours per month in 2016) must continue to be treated by Buyer as full-time until December 31, 2017. This is only one example, and there could be different results under a different set of facts. Moreover, the Service is requesting comments on how to apply the look-back measurement method in the context of corporation transactions. Thus, future guidance may contain different requirements.

In addition, the guidance gives Buyers a “transition period” during which Buyer can measure some or all of the acquired employees’ full time status using the same measurement period and stability period Target used, without creating an impermissible categorization of employees. The “transition period” begins on the date of the corporate transaction and ends on the last day of the first stability period following a standard measurement period that would have applied to the acquired employees absent the corporate transaction and that begins after the date of such corporate transaction (or, if Target uses the monthly measurement method with respect to a category of employees, the last day of the first calendar year that begins after the date of the transaction).

Key Take-aways

When conducting M&A, it is important to obtain data about the hours credited to Target’s employees pre-closing, as Buyer may have to count those hours when determining whether Target’s employees who are hired by Buyer (or an affiliate) are considered “full-time” under the ACA. In addition, for a stock deal, the ACA has created a new item that should be reviewed and addressed in due diligence, including the review of Target’s financial statements, representations and warranties, indemnifications, and, potentially, when considering any escrow.