In a significant development, the Internal Revenue Service ("IRS") has issued new guidance in a Revenue Ruling permitting health flexible spending accounts ("health FSAs") to reimburse participants for the cost of over-the-counter drugs, such as aspirin, antacids, and allergy medicines. Because many health plans are about to send out annual enrollment materials, employers will want to analyze this new guidance now.
Background
The new guidance permitting reimbursements of over-the-counter drugs under health FSAs reverses the previous IRS position. Until the new guidance, the IRS view was that employer sponsored group health plans could not cover over-the-counter drugs on a tax-free basis to employees, nor could employees be reimbursed under health FSAs for these expenses with their pre-tax contributions. The IRS's reversal of its previous position does not, however, affect the deductibility to an individual taxpayer of unreimbursed over-the-counter drug expenses, which are explicitly precluded under the Internal Revenue Code ("Code").
New IRS Guidance
The new guidance states that the definition of "medical care" found in the Code includes an amount paid for the "cure, mitigation, treatment, or prevention" of a disease. Based on this, the IRS has now concluded that amounts reimbursed under a health FSA for over-the-counter drugs are excludable from employees' income. Similarly, employers may include over-the-counter drugs as a covered benefit under their health plans and exclude the benefit from employees' income. The new guidance is available at: http://www.irs.gov/pub/irs-drop/rr-03-102.pdf.
Employer Considerations
In reviewing this guidance, employers should consider the following:
- Health Plan Review.Employers who sponsor group health plans and health FSAs should review the language in their health plan documents, summary plan descriptions ("SPDs"), and forms.Employers should determine whether the current language limits reimbursement to prescription drugs or whether it covers over-the-counter drugs.
- Health Plan Design.Employers need to weigh a number of considerations in determining whether to cover over-the-counter drugs, including the following:
- Scope.Employers who cover over-the-counter drugs will have to decide whether to limit the benefit.Such limits might (i) exclude a specific list of over-the-counter drugs, (ii) include a specific list of over-the-counter drugs, and / or (iii) limit the dollar amount of reimbursements for over-the-counter drugs
- Expenses.Employers may face increased plan administration costs for health FSAs covering over-the-counter drugs due to greater participation and greater utilization.
- Forfeitures. Employers may see fewer forfeitures under health FSAs covering over-the-counter drugs.
- Health Plan Amendment and Revision.If a health plan's language does not reflect the design the employer wants to implement, then the employer will need to amend the health plan.In addition, the employer may need to revise the health plan's SPD and forms to reflect the design.If an employer amends its health plan to cover over-the-counter drugs, the employer needs to carefully determine the appropriate effective date.
- Health Plan Administration.If the employer uses a third-party administrator ("TPA") to administer its health FSA, then the employer should contact the TPA to discuss the TPA's capabilities.
- Employee Communication.The employer will need to communicate the design to its employees.Even if the employer does not change the health plan design (e.g., the employer continues to exclude over-the-counter drugs), employees may have questions.
- Substantiation.While the guidance expands the types of drugs that may be reimbursed, the claims must still be substantiated.Informal guidance suggests that a receipt with the name of the medicine or drug and the date it is purchased is necessary to substantiate an expense.Employers will need to consider whether to require additional substantiation or certifications for these reimbursements.
- Excluded Items.The guidance makes clear that dietary supplements and vitamins are not medical care if merely beneficial to an individual's general health.It is unclear whether vitamins may be reimbursed if a doctor recommends them for a particular medical problem (e.g., iron supplements for anemia).
- Medical Care. Generally, an individual must be sick before being able to incur an expense for medical care.Over-the-counter drugs, however, are often purchased in anticipation of sickness or bought in bulk.It is unclear whether an expense incurred in anticipation of being sick may be reimbursed.
Open Issues
The guidance leaves open a number of issues.
Conclusion
The guidance is a welcome expansion of the reimbursable expenses under health FSAs but also presents design, administration, and compliance challenges. Given the timing of the guidance, employers need to review their health plans now and decide whether to permit reimbursement of over-the-counter drugs. If you have questions relating to the guidance, please contact the attorney you work with in the Employee Benefits Department. You can also call Mike Punt, our department's Communications Coordinator, at 612-340-2867 to be connected to an attorney.