McGuireWoods Healthcare Reform Guide: Installment No. 12
September 13, 2010
This is the 12th in a
series of WorkCite
articles concerning the recently enacted Patient Protection and Affordable
Care Act and its companion bill, the Health Care and Education Reconciliation
Act of 2010 (referred to collectively as the Act). This WorkCite deals
specifically with a new tax rule that applies to the reimbursement for expenses
incurred for over-the-counter (OTC) medicines and drugs that are purchased
without a prescription. The rule affects reimbursements under employer-sponsored
health plans, health flexible spending arrangements (health FSAs), and health
reimbursement arrangements (HRAs), as well as health savings accounts (HSAs) and
Archer medical savings accounts (Archer MSAs)
Under the Internal Revenue Code (Code), an employee who participates in an
employer-sponsored group health plan may exclude from gross income both the
value of coverage under the plan and amounts paid as reimbursements for medical
care, including medical expenses, under the plan. Similarly, distributions for
qualified medical expenses from HSAs and Archer MSAs are tax-free to the
Presently, the cost of OTC medicines and drugs are medical expenses that are
eligible for reimbursement from group health plans (and are qualified medical
expenses eligible for distribution from HSAs and Archer MSAs). The Act, however,
has amended the definition of “medical expenses” in the Code for these purposes
to restrict the reimbursement (and distribution) of funds used to purchase OTC
medicine and drugs going forward.
On September 3, 2010, the IRS issued
2010-59, which provides guidance on the implementation of the new rule.
The new rule generally applies to medical expenses incurred after December
31, 2010. This effective date applies without regard to the fiscal year of the
employer’s plan, and without regard to any applicable post-year-end grace period
for a health FSA.
The same effective date applies to tax-free distributions for qualified
medical expenses from an HSA or Archer MSA.
Reimbursement Restricted to Prescribed Drugs, Insulin, and Prescribed OTC
Under the Act, expenses incurred for medicines and drugs are treated as a
reimbursement for medical expenses only if the medicine or drug is (i) a
prescribed drug (determined without regard to whether such drug is available
without a prescription), or (ii) insulin. Thus, expenses incurred after December
31, 2010, for medicines and drugs may be paid or reimbursed by an employer
health plan, including a health FSA or HRA, only if the medicine or drug:
- Requires a prescription,
- Is available without a prescription (i.e., an OTC medicine or drug) and
the individual obtains a prescription, or
- Is insulin.
Expenses incurred for OTC medicines and drugs purchased without a
prescription before January 1, 2011, may be reimbursed tax-free at any time,
pursuant to the terms of the employer’s plan.
Similar restrictions will apply to HSAs and Archer MSAs. For amounts paid for
expenses incurred after December 31, 2010, a distribution from an HSA or Archer
MSA for a medicine or drug is a tax-free qualified medical expense only if the
medicine or drug is (i) a prescribed drug (determined without regard to whether
such drug is available without a prescription), or (ii) insulin. This change
does not affect distributions made after December 31, 2010, that are for
medicines or drugs purchased on or before that date.
If amounts are distributed from an HSA or Archer MSA for any medicine or drug
that does not satisfy this requirement, the distribution will be for
nonqualified medical expenses. This means that the distributed amounts will
be includable in the participant’s gross income and, generally, will be subject
to a 20% additional tax.
For purposes of the new rule, a prescription means “a written or electronic
order for a medicine or drug that meets the legal requirements of a prescription
in the state in which the medical expense is incurred and that is issued by an
individual who is legally authorized to issue a prescription in that state.”
Comment: To avoid perverse results, plan sponsors might consider
eliminating reimbursement for all, or certain, OTC purchases, even where the
participant has a prescription. Clearly, it will not be cost effective for the
plan to pay the cost of a doctor’s office visit for a participant who coaxes a
prescription for aspirin to ensure reimbursement for its $5.00 purchase price
from the participant’s health FSA.
Reimbursement of Items Other Than Drugs
The new rule is inapplicable to items that are not medicines or drugs,
including equipment (e.g., crutches), supplies (e.g., bandages), and diagnostic
devices (e.g., blood sugar test kits). These items will continue to qualify if
they otherwise meet the definition of medical care, which includes expenses for
the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the
purpose of affecting any structure or function of the body.
Effect on Health FSA and HRA Debit Cards
Current rules under the Code permit the use of debit cards for expenses under
health FSAs and HRAs, subject to certain restrictions. However, the IRS believes
that current debit card systems are not capable of substantiating compliance
with the new rules for OTC medicines or drugs, because the systems are incapable
of recognizing and substantiating that the medicines and drugs are prescribed.
Therefore, except as provided below, for expenses incurred on and after January
1, 2011, health FSA and HRA debit cards may not be used to purchase OTC
medicines and drugs.
The IRS will not challenge the use of health FSA and HRA debit cards for
expenses incurred through January 15, 2011, if the use of the debit cards
complies with the current guidance for their use.
Debit cards may continue to be used for medical expenses other than OTC
medicines or drugs. By contrast, OTC medicine and drug purchases made on or
after June 16, 2011, must be substantiated before reimbursement may be made.
Substantiation is accomplished by submitting:
- The prescription (or a copy of the prescription or other documentation
that a prescription has been issued), and
- Other information from an independent third party that satisfies the
requirements under the proposed cafeteria plan regulations.
Transition Rule for Cafeteria Plan Amendments
Cafeteria plans may need to be amended to conform to the new OTC medicine and
drug requirements. Generally, cafeteria plan amendments may be effective only
prospectively; however, Notice 2010-59 provides that an amendment to conform a
cafeteria plan to the requirements set forth in the Notice may be made effective
retroactively for expenses incurred after December 31, 2010, (or after January
15, 2011, for health FSA and HRA debit card purchases), provided the amendment
is adopted no later than June 30, 2011.
For more information on the Act and Notice 2010-59, please contact the
authors or any member of the McGuireWoods