Let's get right to it. On September 3, 2010, the IRS issued Notice 2010-59 that provides guidance regarding the use of tax-favored vehicles (like FSAs, HSAs and HRAs) to pay for over-the-counter medicines and drugs.

The new guidance is effective for purchases on or after January 1, 2011, so plan years before then are not affected. The guidance provides for an amendment of the definition of "medical expenses" under employer-sponsored accident and health plans (FSAs and HRAs) and the definition of "qualified medical expenses" under HSAs and MSAs. Beginning January 1, 2011, over-the-counter medicines and drugs will only be reimbursable from these plans if the individual obtains a prescription. The new rules clarify that 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.

Note: Insulin is exempt from the new rules and remains reimbursable without a prescription.

The new rules make it clear that this does not affect the reimbursement of medical supplies and diagnostic devices, such as crutches, eye glasses, bandages and blood sugar test kits. These items can qualify as medical care under IRS Code 213(d)(1) which covers expenses for the "diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body."

Because there is some possible overlap in plan years, the new rules make it clear that medications purchased prior to 1/1/2011 are not impacted, even if the reimbursement is not made until after 1/1/2011. But be aware that purchases made on or after 1/1/2011 are restricted even if they are intended to be used for reimbursements under a health FSA for the 2010 year account balance under the 2 1/2 month grace period. So that means that account balances for the 2010 plan year that carry over into 2011 because of the grace period cannot be used to reimburse for over-the-counter medications if they were purchased AFTER 1/1/2011.

For those that use debit cards for their reimbursement accounts, the new rules also clarify 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. So beginning on 1/1/2011, debit cards cannot be used to purchase over-the-counter medicines and drugs. Plan participants need to be notified of this change immediately so that they don't encounter unwanted surprises when they go to purchase medications after the first of the year.

As a side note on this debit card issues, the IRS will not challenge the use of debit cards for over-the-counter purchases made through 1/15/2011 if you currently have a debit card system in place. However, after 1/16/2011, over-the-counter purchases can no longer be made with the debit card.

Based on the issuance of this guidance, it is clear that plans have to be amended to provide for these limitations and notices should be issued to participants in advance of their 2011 elections.