New Guidance for Flexible Spending Accounts

and Health Reimbursement Accounts

M. Travis DeHaven, Leah M. Singleton

Troutman Sanders LLP

Atlanta, Georgia

The Internal Revenue Service recently released important guidance relating to Flexible Spending Accounts (“FSA”) and Health Reimbursement Accounts (“HRA”). First, Revenue Ruling 2003-43 announced guidance on the use of debit cards for reimbursement of health expenses by FSA and HRA. Second, Revenue Ruling 2003-102 announced that over-the-counter medications are now a qualified expense under FSA or HRA.

Debit Card Ruling

Debit card usage in FSA or HRA is attractive to many employers because debit cards allow a plan to pay providers at the time of the service or sale. Theoretically, debit cards will alleviate a participant’s cash-flow concerns traditionally associated with using FSA and HRA due to the waiting period for reimbursement of claims.

In the past, the waiting period for reimbursement of a claim was necessary to meet the substantiation rules under the regulations. The substantiation rules require a written statement from an independent third-party stating the amount of the medical expense and a written statement from the participant stating that such medical expense had not been reimbursed under another health plan. However, the recent Ruling sets forth two factual situations involving the use of debit cards in FSA or HRA that now also meet the substantiation requirements.

In summary, the following guidelines must be followed when using debit cards in a FSA or HRA:

• The participants must certify upon enrollment and each year that the debit card will only be used for eligible medical expenses for themselves, their spouses and dependents; that any expense paid with the debit card will not be reimbursed under another health plan; and that they will retain the invoices, receipts, or other documentation for any expense paid with the debit card.

• Certification must be printed on the back of the debit card, and the participant understands that this certification is reaffirmed each time the debit card is used.

• The participant’s use of the debit card is automatically cancelled at termination of employment.

• The debit card is limited to the annual maximum amount of coverage available in the participant’s FSA or HRA. When using the debit card, the merchant or service provider is paid the full amount of the charge, and the participant’s maximum amount of coverage is decreased by the amount.

• The debit card is only usable at specific health and medical care providers authorized by the employer.

• Every claim paid with the debit card must be substantiated. Accordingly, the FSA or HRA plan documents must contain procedures for automatic substantiation, manual substantiation and recovery of improper payments.

It is clear from the ruling that every transaction must be substantiated, either automatically or manually. Using a sampling technique to substantiate only certain transactions does not meet the requirements for substantiation.

Automatic substantiation may be met in three situations. First, automatic substantiation exists when the dollar amount of the transaction at the provider equals the dollar amount of the co-payment under the plan. Second, automatic substantiation exists when an expense matches an expense previously approved for the same amount, provider, and time period. Third, automatic substantiation exists when the merchant or third-party provides information to verify that a charge is for a medical expense at the time of the sale. In these three automatic substantiation situations, the participant is not required to submit receipts or invoices for review.

For all other transactions, the participant must meet the substantiation requirements by submitting receipts, invoices or other documentation that describe the service or product, the date of the service or sale, and the amount. These manual transactions are treated as conditional pending confirmation of the charge.

If a claim has been paid and is later found not to qualify for reimbursement under the FSA or HRA, the participant must pay back the improper payment. The payments may be deducted from the participant’s wages or offset in the same coverage period with one or more substantiated claims until the improper claim is recouped. Further, to ensure future violations do not occur, the plan is required to terminate the debit card until the amount is paid back.

Over-the-Counter Medication Ruling

Allowing reimbursement for over-the-counter drugs through FSA or HRA will allow participants to purchase such medication with pre-tax dollars. The IRS noted that this change is appropriate as more prescription drugs become available to consumers without a prescription. Such reimbursements are allowed for the 2003 plan year.

Employers wishing to allow reimbursement for over-the-counter drugs should be cognizant of certain limitations. First, for purposes of itemizing medical deductions on an individual’s personal federal income tax return, the cost of over-the-counter drugs is not deductible. Second, the cost of items that are merely beneficial to health, such as vitamins, toiletries and cosmetics, are not reimbursable.

What Employers Should Consider

Despite the recent guidance, employers should also consider several issues before offering debit cards, including complying with HIPAA requirements regarding private health information, reporting payments to medical service providers on Form 1099-MISC, amending plan documents and summary plan descriptions, reviewing vendor agreements for substantiation of every transactions, and instituting internal safeguards and guidelines to ensure compliance.

Further, if the employer wishes to permit reimbursement through the FSA or HRA for over-the-counter drugs, the plan language should be reviewed and amended, if needed, to clarify that non-prescription drugs are eligible expenses. Similarly, enrollment forms and communications should be modified to reflect this new type of reimbursable expense.

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