On September 3, 2010, the Internal Revenue Service (the "IRS") issued guidance under the Patient Protection and Affordable Care Act (the "Affordable Care Act") regarding the use of tax-favored vehicles to pay for over-the-counter medicines and drugs. The new guidance is set forth in IRS News Release IR-2010-95, IRS Notice 2010-59 and Revenue Ruling 2010-23.

The new guidance is effective for purchases on or after January 1, 2011, and amends the definition of medical expenses under employer-sponsored accident and health plans (including health flexible spending accounts ("health FSAs"), health reimbursement accounts ("HRAs")) and the definition of qualified medical expenses under health savings accounts ("HSAs") and Archer Medical Savings Accounts ("Archer MSAs"). Beginning January 1, 2011, over-the-counter medicines and drugs will only be reimbursable from such tax-favored arrangements if the individual obtains a prescription. For purposes of these new rules, 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.

Insulin is exempt from the new rules and remains reimbursable without a prescription. Similarly, the new rules do not affect the reimbursement of medical supplies and diagnostic devices, such as crutches, eye glasses, bandages and blood sugar test kits. Such items can qualify as medical care (and thus be reimbursable) under Internal Revenue Code Section 213(d)(1), which encompasses expenses for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body (but excludes expenses for items merely beneficial to the general health of an individual, such as vacation expenditures). The new rules do not affect medicines or drugs purchased before January 1, 2011, but for which reimbursement is not made until on or after January 1, 2011. However, the new rules will affect all purchases on or after January 1, 2011, even for reimbursements under a health FSA for the 2010 year account balance under a grace period provision.

One of the most noticeable immediate effects of the new rules is that debit cards will no longer be able to be used for over-the-counter medicines or drugs because current debit card systems are not capable of recognizing and differentiating when over-the-counter medicines or drugs are obtained in conjunction with a prescription. Therefore, beginning January 1, 2011, debit cards cannot be used to purchase over-the-counter medicines and drugs. However, the IRS will not challenge the use of debit cards for such purchases through January 15, 2011, under a previously approved debit card reimbursal system. On and after January 16, 2011, over-the-counter medicine/drug purchases must be substantiated as having been made with a prescription prior to reimbursement, meaning that debit cards will no longer be able to be used for purchases of over-the-counter medicine or drugs.

Employers should review their cafeteria plan language to determine whether or not amendments are required to comply with the new rules. Under Proposed Treasury Regulation section 1.125-1(c), cafeteria plans may only be amended prospectively; however, IRS Notice 2010-59 permits the retroactive amendment of such plans until June 30, 2011, for purposes of complying with the new rules.