New Guidance. The IRS recently issued Notice 2010-59 regarding the reimbursement of over-the-counter medicines and drugs by employer-provided health plans. PPACA changed the definition of medical expenses in the Code for purposes of reimbursement of medicines and drugs.
Under the new definition, expenses incurred for medicines or drugs can be paid or reimbursed as a medical expense by an employer-provided plan, including a health FSA or HRA, only if the medicine or drug (1) requires a prescription, (2) is available without a prescription (for example, an over-the-counter medicine or drug) and the individual obtains a prescription, or (3) is insulin. Distributions from HSAs or Archer MSAs for a medicine or drug are considered tax-free qualified medical expenses only if one of these three conditions is met. This change does not affect HSA or Archer MSA distributions for medicines or drugs made before January 1, 2011, nor does it affect distributions made after December 31, 2010, for medicines or drugs purchased on or before that date.
For purposes of the above rule, a prescription is 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.
The new rule does not apply to items that are not medicines or drugs, including equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits. Such items may qualify as medical care if they otherwise meet the definition of medical care under the Code, 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. However, expenses for items that are merely beneficial to the general health of an individual, such as an expenditure for a vacation, are not expenses for medical care.
Effective Date. The new rules are generally effective for expenses incurred after December 31, 2010. Expenses incurred for over-the-counter medicines or drugs purchased without a prescription before January 1, 2011, may be reimbursed tax-free at any time, pursuant to the terms of the employerʼs plan.
Application to Health FSA and HRA Debit Cards. The guidance notes that current debit card systems are not capable of substantiating compliance with the new rules regarding over-thecounter medicines or drugs because the systems are incapable of recognizing and substantiating that the medicines or drugs were prescribed. Therefore, for expenses incurred on and after January 1, 2011, health FSA and HRA debit cards cannot be used to purchase over-the-counter medicines or drugs except as provided below. Debit cards can continue to be used for medical expenses other than over-the-counter medicines or drugs.
The guidance further indicates that to facilitate significant changes to existing systems, 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 existing guidance.
On and after January 16, 2011, over-the-counter medicine or drug purchases must be substantiated before reimbursement can be made. Substantiation is accomplished by submitting the prescription (or a copy of the prescription or other documentation that indicates a prescription has been issued) for the over-the-counter medicine or drug, and other required information from an independent third party.
Transition Rule for Cafeteria Plan Amendments. Cafeteria plans may need to be amended to conform to the new over-the-counter drug requirements. While cafeteria plan amendments may not be effective retroactively, an amendment to conform a cafeteria plan to the requirements set forth in Notice 2010-59 that is adopted no later than June 30, 2011, 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).