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Beware: M&A Activity Can Trigger Unexpected Tax Issues

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The IRS has an Employee Plans Team Audit (EPTA) program to enforce the tax rules for employee benefit programs in large companies. According to the tax agency, one of the top ten concerns of this group of auditors is how mergers and acquisitions affect compliance with employee benefit rules. Recurring or uncorrected compliance failures can lead to tax penalties or worse — such as outright disqualification of tax-favored employee retirement and benefit programs.

Here are four key issues IRS auditors are told to look for in the M&A environment:

  1. Profit-Sharing Allocations Made to Employee Accounts.IRS examiners check whether timely allocations of profit sharing plan contributions are made to the accounts of employees of the acquired business. For example, these allocations may fall through the cracks due to incompatibilities between the payroll systems of the acquired company and the acquirer.
  2. Employer Matching Contributions Made to Employee Accounts.The IRS will examine whether the acquiring company continues to make proper retirement plan matching contributions to the accounts of employees of the acquired business. Problems can arise due to payroll system incompatibilities or misunderstood differences between the plans operated by the two companies.  Improperly calculated matching contributions for employees of the acquired business can also occur because the acquiring company uses faulty data for employee compensation amounts and/or incorrect employee participation beginning dates.
  3. The Operation of Merged Plans.Retirement plans operated by the acquiring and acquired companies are often merged into a single plan after an acquisition. When this happens, IRS auditors will make sure that employees of the acquired company are not improperly prevented from exercising distribution and loan options that are mandated by law.
  4. The Acquired Company’s Accrued Contribution Obligations.When an acquiring company assumes a target company’s accrued obligations to make employee benefit plan contributions, these liabilities generally must be capitalized as part of the cost of the acquired stock or assets. In other words, the acquiring company generally cannot claim current tax deductions when these accrued contribution liabilities are paid in cash. IRS auditors will check for proper treatment.

Employee Benefit Team Audits – The concept of using a team of specialists to conduct broad-scope audits of the benefit plans of large corporations began with the restructuring of the IRS in 1998. The IRS audit team may consist of benefit specialists, a computer specialist, actuary, attorney, economist and others. Specialized training is provided to team members. The IRS reports that it has approximately 50 plan sponsors under examination at a time.

Conclusion: Failing to proactively address M&A-related employee benefit issues can adversely affect the acquiring company, as well as employees of the acquired business. Specifically, failing to comply with applicable rules could cause your company to lose valuable tax benefits such as federal payroll tax exemptions for employee salary reduction contribution amounts. It could also result in costly IRS interest charges and penalties. These negative outcomes can be avoided with proper analysis and planning. Contact your tax advisor experienced in mergers and acquisitions for more information about these important issues.

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