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Merger and Acquisition Rules for Health FSA

There are several options to address Health FSA issues in a M&A situation.

Question: What are the health FSA options for employers in a M&A situation?

Compliance Team Answer:

Upon acquiring a selling entity that sponsors a health FSA for its employees, the buyer will have two options to address the buyer’s health FSA:

Option 1: Terminate the Seller’s Health FSA

The default approach would be to terminate the seller’s health FSA as of the day prior to the closing. That would mean employees would have a run-out period (generally 90 days) from the date of termination to submit claims already incurred prior to the closing. Then the employees would become eligible under the buyer’s health FSA as of the date of the close.

Advantage: In that scenario, the employees could make a new election under the buyer’s health FSA for the remainder of the plan year because they would have lost coverage under the prior plan. It would in effect provide a new hire right to elect another full $2,600 under the buyer’s health FSA for the reminder of the plan year.

Disadvantage: The downside of this approach is that terminating the seller’s health FSA will likely mean that many employees forfeit funds. Many employees will not have incurred medical expenses through the date of termination, and therefore will have no ability to submit claims. This is a common occurrence in M&A scenarios, and exactly what the second option described below is intended to avoid.

Option 2: Continue Health FSA Coverage Through the End of the Plan Year

There are also special M&A rules for health FSAs available as an alternative to the plan termination route described in the first option above.

Advantage: The IRS provides two options if the buyer would like to continue the seller’s health FSA through the rest of the plan year in which the acquisition occurs:

  • Coverage Under Seller’s Health FSA with Salary Reductions Through Buyer: The parties may agree to have seller’s employees continue to participate in seller’s health FSA through the end of the plan year in which the deal closes. In this case, the buyer will be responsible for taking the employee contributions after the deal closes.
  • Coverage and Salary Reductions Under Buyer’s Health FSA: The parties may alternatively agree for the buyer to cover the seller’s employees under the buyer’s health FSA for the remainder of the plan year in which the deal closes. In this case, the seller’s existing FSA balances are rolled over to the buyer’s health FSA. After the deal closes, the seller’s employees submit all claims to the buyer’s health FSA (even those incurred prior to the acquisition but not yet reimbursed).

Disadvantage: Under either approach in these special M&A rules, no mid-year election change is permitted under the Section 125 permitted election change event rules. The seller’s employees do not lose eligibility for the seller’s health FSA as a result of the acquisition (because they retain eligibility under the seller’s health FSA or buyer’s health FSA). Therefore, these employees remain subject to their existing health FSA elections, which may not be changed for the remainder of the year (unless they experience a permitted election change event).

Summary

To summarize, the two approaches are:

  • Continue employees’ elections and balances from the seller’s health FSA through buyer (either via the seller’s or buyer’s health FSA) for the remainder of the plan year. Under this approach, no election change is permitted.
  • Terminate the seller’s health FSA upon closing and provide a run-out period to submit claims incurred prior to the termination (generally 90 days). Under this approach, employees may make a new election for the remainder of the plan year in the buyer’s health FSA (up to a full new $2,600). However, some employee’s will likely forfeit contributions made to the seller’s FSA.

Regulations:

IRS Rev. Rul. 2002-32:

Under the asset sale described in both Situation (1), where transferred employees maintain their existing health FSAs under S’s cafeteria plan, and in Situation (2), where B agrees to cover the transferred employees who have elected to participate in S’s health FSA, there is no loss of eligibility for coverage under § 1.125-4. Therefore, transferred employees continue to be subject to their existing FSA elections and may not change those elections during the remainder of the plan year of the asset sale (unless an event occurs thereafter which permits an election change under § 1.125-4).

Holding

In an asset sale, transferred employees who have elected to participate in health FSAs under seller’s cafeteria plan may continue to exclude the salary reduction amounts and medical expense reimbursements from gross income without interruption and at the same level of coverage after becoming employees of buyer either when seller agrees to continue its existing health FSAs for the transferred employees as described in Situation (1) or when buyer agrees to adopt a continuation of seller’s health FSAs for the transferred employees as described in Situation (2).


Brian Gilmore

About the author

Brian Gilmore

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law. Connect with Brian on LinkedIn.


The information provided is of a general nature and an educational resource. It is not intended to provide advice or address the situation of any particular individual or entity. Any recipient shall be responsible for the use to which it puts this document. Newfront shall have no liability for the information provided. While care has been taken to produce this document, Newfront does not warrant, represent or guarantee the completeness, accuracy, adequacy, or fitness with respect to the information contained in this document. The information provided does not reflect new circumstances, or additional regulatory and legal changes. The issues addressed may have legal, financial, and health implications, and we recommend you speak to your legal, financial, and health advisors before acting on any of the information provided.

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