IRS issues guidance on FSA reimbursement

Critics of impending changes to medical spending accounts have been arguing for months to push back provisions that will take effect by the beginning of next year. Last week, the IRS issued guidance on such changes that aims to clarify certain restrictions on medical expense reimbursement through these accounts.

According to IRS guidelines, beginning Jan. 1, employees won't be able to make over-the-counter drug purchases using their flexible spending account or health reimbursement account unless they have a prescription.

Guidelines state the cost of an OTC drug or medicine can't be reimbursed unless the item is a prescribed drug, or if the medication is available over the counter and the purchaser obtains a prescription. Insulin will also be reimbursed even if there isn't a prescription.

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The change also doesn't affect other health care expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles.

Non-drug or non-medicine items like crutches, bandages and blood sugar tests will still qualify for reimbursement by a health FSA or HRA regardless if they are purchased using a prescription.

However, the OTC change won't take effect until after Dec. 31, which means account holders have until then to stock up on drugs like Aspirin, which doesn't require a prescription for reimbursement. Claims for 2010 expenses can also be reimbursed in 2011.

But for any expenses incurred on and after Jan. 1, account holders will need to obtain the required prescription, which the IRS has defined as "written or electronic order for a medicine or drug that meets the legal requirements of a prescription in the state in which a medical expense is incurred and that is issued by an individual who is legally authorized to issue a prescription in that state."

Those with health savings accounts will also see an increased penalty for expenses that don't qualify for reimbursement. According to the IRS, withdrawals for OTC, non-prescribed drugs or non-medical-related items will be penalized by 20 percent instead of the current 10 percent.

Effective dates and grace period

According to the IRS, reimbursements for expenses incurred after Dec. 31, 2010 are restricted to prescribed drugs, insulin and OTC drugs that are prescribed. The effective date applies regardless of whether the plan year for the employer's plan is a fiscal or calendar year or whether there is no plan year.

As for HSAs or Archer MSAs, tax-free distributions for qualified medical expenses from these accounts are restricted to prescribed drugs, OTC medicines that are prescribed, or insulin.

At a company's discretion, health FSAs can include a grace period that extends a few months into the following year after a plan year has ended. According to guidelines, if a health FSA includes a grace period provision, costs for OTC medicines and drugs purchased without a prescription during the first 2 1/2 months of 2011 will not be eligible for reimbursement.

Debit cards

Debit card systems currently can't recognize and substantiate whether medicines or drugs were prescribed. So they'll be useless next year to purchase OTC drugs or medicines. Participants will need to purchase the medicine, then provide a receipt and prescription (or copy of prescription), or receipt and Rx number.

However, the IRS is going to allow time for the plan to ensure that the card is reprogrammed, so it will allow card usage until Jan. 15, 2011.

Groups challenge FSA provision date

The IRS released official guidance regarding the use of FSAs and other tax-favored arrangements on Sept. 3, and the fast-approaching effective date has industry groups and benefit administrators scrambling to prepare.

Grassroots advocate Save Flexible Spending Plans has pushed for a 2014 implementation date to coincide with the start date of many other provisions under the Patient Protection and Affordable Health Care Act.

"This common-sense approach would provide a much better transition period for participants, including those battling chronic conditions, to be educated about the new rules and have a reasonable amount of time to find new ways to finance their health care costs," the group said in a statement released in March.

"This restriction will hurt millions of consumers who rely on their FSAs to manage their out of pocket health care costs and pay for necessary over-the-counter therapies," notes Joe Jackson, CEO of WageWorks Inc., a benefits company based in San Mateo, Calif. "If Congress is intent on putting this provision into effect, they should at least push back the deadline so that consumers and especially retailers are ready for the transition."

Q & A on OTC medications and drugs:

Q. How are the rules changing for reimbursing the cost of over-the-counter medicines and drugs from health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs)?

A. Section 9003 of the Affordable Care Act established a new uniform standard for medical expenses. Effective Jan. 1, 2011, distributions from health FSAs and HRAs will be allowed to reimburse the cost of over-the-counter medicines or drugs only if they are purchased with a prescription. This new rule does not apply to reimbursements for the cost of insulin, which will continue to be permitted, even if purchased without a prescription.

Q. How are the rules changing for distributions from health savings accounts (HSAs) and Archer Medical Savings Accounts (Archer MSAs) that are used to reimburse the cost of over-the-counter medicines and drugs?

A. In accordance with Section 9003 of the Affordable Care Act, only prescribed medicines or drugs (including over-the-counter medicines and drugs that are prescribed) and insulin (even if purchased without a prescription) will be considered qualifying medical expenses and subject to preferred tax treatment.

Q. When will the changes become effective?

A. The changes are effective for purchases of over-the-counter medicines and drugs without a prescription after Dec. 31, 2010. The changes do not affect purchases of over-the-counter medicines and drugs in 2010, even if they are reimbursed after Dec. 31, 2010.

Q. How do I prove that I have purchased an over-the-counter medicine or drug with a prescription so that I can get reimbursed from my employer's health FSA or an HRA?

A. If your employer's health FSA or HRA reimburses these expenses, you would provide the prescription (or a copy of the prescription or another item showing that a prescription for the item has been issued) and the customer receipt (or similar third-party documentation showing the date of the sale and the amount of the charge). For example, documentation could consist of a customer receipt issued by a pharmacy that reflects the date of sale and the amount of the charge, along with a copy of the prescription; or it could consist of a customer receipt that identifies the name of the purchaser (or the name of the person for whom the prescription applies), the date and amount of the purchase and an Rx number.

Q. How does this change affect over-the-counter medical devices and supplies?

A. The new rule does not apply to items for medical care that are not medicines or drugs. Thus, equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits will still qualify for reimbursement by a health FSA or HRA if purchased after Dec. 31, 2010, and a distribution from an HSA or Archer MSA for the cost of such items will still be tax-free, regardless of whether the items are purchased using a prescription.

Q. Will I need a prescription to use my health FSA, HRA, HSA or Archer MSA funds for insulin purchases after Dec. 31, 2010?

A. No. You can continue to use your health FSA, HRA, HSA or Archer MSA funds to purchase insulin without a prescription after Dec. 31, 2010.

Q. I use health FSA funds for my co-pays and deductibles. Will I still be able to reimburse those expenses with health FSA funds after Dec. 31, 2010?

A. Yes. Co-pays and deductibles continue to be reimbursable from a health FSA after Dec. 31, 2010. Similarly, funds from an HRA can continue to be used for these expenses and a distribution from an HSA or Archer MSA for these purposes will be tax-free.

Q. My company gives me two extra months beyond the end of the year to submit claims for health FSA expenses incurred during the year. What happens if I purchase over-the-counter medicines or drugs without a prescription in 2010 but do not submit the claim for those expenses until January 2011? Will they qualify for reimbursement?

A. Yes. The new restriction on plan reimbursements for the cost of over-the-counter medicines or drugs without a prescription applies only to purchases that are made after 2010.

Q. My company's health FSA includes a provision for a grace period, so that if I don't spend all of the money in my health FSA by Dec. 31 in a given year, I can still use the amount left in my health FSA at the end of the year to reimburse expenses I incur during the first 2 1/2 months of the following year. If I buy over-the-counter medicines or drugs without a prescription during the 2 1/2 month grace period of 2011, can I still use the amount left in my health FSA at the end of 2010 to reimburse those expenses?

A. No. The change applies to purchases made on or after Jan. 1, 2011. Thus, even if your employer's plan includes the 2 1/2 month grace period provision, the cost of over-the-counter medicines and drugs purchased without a prescription during the first 2 1/2 months of 2011 will not be eligible to be reimbursed by a health FSA.

Q. If my plan issues a debit or credit card that I use to pay for over-the-counter medicines or drugs, will I still be able to use the card to purchase over the counter medicines or drugs after Dec. 31, 2010?

A. Generally, no. The plan must ensure that the card is reprogrammed no later than Jan. 15, 2011, so that the card can no longer be used to purchase over-the-counter medicines or drugs. For further information, see IRS Notice 2010-59. If your employer's plan reimburses expenses for over-the-counter medicines and drugs, you can seek reimbursement for these expenses by presenting the information described above in the answer to the question "How do I prove that I have purchased an over-the-counter medicine or drug with a prescription so that I can get reimbursed from my employer's health FSA or an HRA?"

Q. If I use HSA or Archer MSA funds to reimburse the cost of over-the-counter medicines or drugs purchased after Dec. 31, 2010 without a prescription, what taxes will I incur?

A. If you have an HSA or Archer MSA, the amount of the distribution for expenses that are not qualifying medical expenses will be includable in your gross income and subject to an additional tax of 20%.

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