IRS PROVIDES GUIDANCE ON OVER-THE-COUNTER MEDICINES AND DRUGS

The Internal Revenue Service has released notice of guidance regarding changes to Section 9003 of the Patient Protection and Affordable Act (Affordable Care Act) which changes employee reimbursements for over-the-counter medicines and drug s from employer flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), health savings accounts (HSAs) and Archer Savings Accounts (Archer MSAs).  These changes will ultimately affect both employers and employees who offer and participate in any of these programs.

Newly revised sections of the Affordable Care Act, (originally enacted March 23rd of this year), includes an updated definition of medical expenses for employer–provided accident and health plans, including HSAs and FSAs, as well as a change in the definition of what qualifies as a tax-free qualified medical expense for HSAs and (Archer MSAs).  These changes made to section 9003 will generally apply to purchases made after December 31, 2010.  Any purchases made in 2010 are still considered reimbursable in 2011, if allowable under the particular reimbursement plan.

The addition of §106(f) includes a revised definition of a “medical expense” as it relates to over-the counter drugs.  Under 106(f), expenses incurred for medicines or drugs may be paid or reimbursed by an employer-provided plan, including a health FSA or HRA, only if: (1) the medicine or drug requires a prescription, (2) is available without a prescription (an over-the counter medicine or drug) and the individual obtains a prescription, or (3) is insulin. 

Sections 223(d)(2)(A) and 220(d)(2)(A) were also amended, with respect to HSAs and Archer MSAs.  Much the same as §106(f), a distribution from an HSA or an Archer MSA for medicines or drugs is considered a tax free qualified medical expense, only if: (1) the medicine or drug requires a prescription, (2) is an over-the counter-medicine or drug and the individual obtains a prescription (regardless of whether the medicine or drug requires a prescription), or (3) is insulin.  For purposes of the newly added sections, a prescription has been defined  as “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 rules in §§223(d)(2)(A) and 220(d)(2)(A) do not apply to such items as crutches, supplies such as bandages, and diagnostic devices such as blood sugar kits as long as they meet the definition of “medical care”.  The IRS is aware that many of the current debit systems are incapable of recognizing and substantiating compliance with the new §106(f), further guidance has been provided on the use of FSA and HRA debit cards  after December 31, 2011.  The IRS has indicated that it will not challenge the use of the debit cards at providers or merchants that do not have an inventory approval system (IIAS) for expenses incurred through January 15, 2011, but after that date, over-the-counter medicine or drug purchases at all providers and merchants (whether or not they have an IIAS), must be substantiated before reimbursement may be made.  Debit cards may continue to be used for medical expenses other than over-the-counter medicines and drugs.

To conform to the new over-the- counter drug requirements, cafeteria plans may also need to be amended.  IRS guidance indicates that “an amendment to conform a cafeteria plan to the requirements set forth in this Notice 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 and HRA debit card purchases).”