Employment Taxes, M&A and The Rules of Three

How better awareness of employee movements between legal entities can help contribute to tax savings 

By Tom Towson 

The topic of employment taxes may not be top of mind for healthcare leaders navigating the merger and acquisition (M&A) landscape, but it’s a meaningful consideration with material financial impacts. These “employment taxes” include: Social Security (FICA), federal unemployment (FUTA), and state unemployment insurance (SUI).  

While many organizations in the healthcare space are non-profit, a significant number of service providers, care centers and facilities are for-profit, pay employment taxes and have either been, are, or may soon be, actively involved in an M&A event. In addition, though many non-profit healthcare organizations do not pay FUTA or SUI taxes, they must still pay FICA tax. 

Despite the economic shock of the pandemic, the pace of M&A in healthcare does not indicate any slowdown in activity.  “Payers and providers with strong balance sheets as well as private equity funds with investment dollars earmarked for healthcare are well-positioned to pursue acquisitions,” commented Nick Donkar at PwC in a Q&A from July 2020. A survey conducted by Bank of America in partnership with HealthLeaders reports that the single largest driver of healthcare provider consolidation is reduced costs. There are many factors driving M&A in the healthcare space, suggesting  it will remain active in 2021.

As part of an M&A event, employment tax resolution should be considered as part of the due diligence and tax planning processes, but it can easily be missed. There are employment tax considerations when employees move from one legal entity to another, resulting in a potential financial impact to the buying organization. Healthcare operators and suppliers who are considering or exploring acquisitions should try to put employment tax reviews and analyses in place as early in the process as possible. 

Regardless of where, or when, employment taxes are considered, there are three main “rules of three” that employers should keep in mind when it comes to employment tax planning associated with an M&A event. 

Rule #1: Compliance with the Big Three — FICA, FUTA and SUI Taxes

The first rule of three is to stay mindful of compliance requirements with FICA, FUTA and SUI taxes from pre-close to post-close. Most executives involved in due diligence know to actively seek the advice of specialized tax advisors during the early planning stages, but sometimes giving careful consideration to the implications of these three employment tax buckets can get lost in the myriad of details being explored.  

Each state has its own set of rules on how the movement of employees impacts current and future SUI tax rates, for those healthcare organizations that are merit rated (i.e., organizations that pay SUI tax versus reimburse the state for each unemployment benefit paid out to former employees). 

It is also one of the only taxes where the tax rate varies year-over-year.  By taking advantage of options available in many states, healthcare organizations involved in an M&A event can often benefit from lower SUI tax rates.  Taking advantage of these options requires the filing of required compliance documents, and conversely not filing required compliance documents can result in the assessment of penalties and/or the assignment of penalty rates. 

Adherence to compliance requirements also comes into play when addressing the restart of annual taxable wage base limits when an M&A event occurs mid-year (i.e., after the first payroll date and before the last payroll date).   Wage base calculations are critical and can impact categories of employees differently. For example, Medscape reported that physician salaries continue to trend upwards and are well over the 2021 Social Security wage base of $142,800. Because of this, physicians and other high wage earners need to be taken into consideration when addressing a restart of FICA tax.   

As most payroll and payroll tax professionals know, once an employee’s wages exceed the taxable wage base for FICA, FUTA, and SUI tax purposes, wages are no longer subject to taxation for the remainder of the calendar year. Also, the taxable wage base restarts with each new hire. But the rules are different when it comes to an M&A event,  which is why payroll and payroll tax professionals should be aware of the successor employer provisions. In most cases, once the deal is closed and employees have been transferred to the buyer’s payroll, these provisions allow the buyer to treat the employees of the acquired company as existing employees, through the use of a taxable wage base credit equal to the wages paid while with the acquired company. But, sometimes the qualifying criteria for successor employer status differ state-by-state for SUI tax purposes and can differ if an organization is acquiring an entire company versus a division or portion of a company. And, misapplication of “successor employer” provisions might result in overwithholding and overpayment of FICA taxes. Preventing tax overpayments is much more desirable than having to recoup the tax from the IRS or state workforce agencies, reinforcing the need for advanced planning. 

Rule #2: Three-Year Lookback to Review, Revise and Recover

Even if employment tax implications are overlooked during the due diligence and planning phases, or following an M&A event, the good news is that employers often have three years to recover overpaid employment taxes. This is a second “rule of three” for acquiring companies: the three year potential to review, revise and potentially recover inadvertent tax overpayments during the lookback period. 

For example, the Equifax Employment Tax Team recently worked with a national healthcare services provider that acquired a sub-service company. The acquired team became employees of the national provider in the middle of the calendar year; however, the national provider incorrectly restarted their annual taxable wage bases, treating the acquired employees as “new hires” for FICA, FUTA and SUI tax purposes. In their case, restarting the taxable wage base limits was not necessary. Equifax worked with the customer to review, revise, and ultimately recover over $500,000 in overpaid taxes.

Rule #3: Three Ways to Help Recover Overpaid Employment  Taxes 

As indicated earlier, when healthcare organizations engage in an M&A event or even an internal workforce reorganization or perhaps implement a new payroll system, there is the potential to overpay employment taxes. The third “rule of three” relates to three things that healthcare organizations can do to help avoid tax duplication:

1. Prevent the overpayment of tax on the front end by understanding and applying the “successor employer” provisions at the time employees are transferred from one legal entity to another.
2. Determine if an overpayment has occurred and quantify its significance using employee-level detail supplied by the seller, making sure to have the right to this data prior to closing the deal.
3. Amend or revise employment tax filings, including Forms 941 (FICA), 940 (FUTA) and state quarterly contribution reports (SUI).

While employment taxes rarely drive decisions relating to the structure of an M&A event, pre-transaction planning can sometimes result in significant tax cost savings and require only minor structural changes that won’t disrupt other organizational objectives.  

As demonstrated in the earlier example, post-transaction lookback reviews may provide material tax cost savings even if due diligence wasn’t performed on the front end. Every deal comes with strategic levers that the buyer seeks to maximize in a timely manner, beyond integrating cultures, managing a new workforce, and streamlining technology and operational redundancies. Working with a dedicated team of employment tax advisors during the M&A due diligence and planning phases, or even after the fact, can result in significant savings, or recovered taxes, for healthcare organizations. It’s well worth a look, or a look back as the case may be, at past, current and future deals to help ensure that your healthcare organization is protected against the overpayment of employment taxes.

Tom Towson is the Director of Employment Tax Consulting at Equifax, assisting employers with identification and recovery of their overpaid tax, helping them with their management of employment tax costs, and helping them identify compliance risks. He has more than 30 years of consulting experience in all aspects of taxation, specializing in employment tax matters associated with mergers & acquisitions, tax authority representation, and strategic planning.