September 22, 2010
 

IRS Issues Guidance on Health Care Reform Over-the-Counter Drug Restrictions

By Nancy K. Campbell

 

The Patient Protection and Affordable Care Act (the “Affordable Care Act”) added a new Section 106(f) to the Internal Revenue Code (the “Code”).  Under Section 106(f), a new uniform standard applies to health flexible spending accounts (“health FSAs”) and health reimbursement arrangements (“HRAs”).  Under the new standard, the cost of an over-the-counter medicine or drug cannot be reimbursed from the account unless a prescription is obtained.

The change does not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eye glasses, contact lenses, co-pays, and deductibles.  The new standard applies only to purchases made on or after January 1, 2011, so claims for medicines or drugs purchased without a prescription in 2010 can still be reimbursed in 2011, if allowed by the employer’s plan.

A similar rule goes into effect on January 1, 2011 for health savings accounts (“HSAs”) and Archer medical savings accounts (“Archer MSAs”). 

On September 3, 2010, the Internal Revenue Service issued guidance on the changes made by Section 106(f) in the form of Notice 2010-59 and Revenue Ruling 2010-23. 

Payment or reimbursement restricted to prescribed drugs, insulin, and over-the-counter drugs that are prescribed

New Section 106(f) provides that for purposes of Section 105 and 106 of the Code, beginning after December 31, 2010, expenses incurred for a medicine or a drug are treated as a reimbursement for medical expenses only if such medicine or drug is a prescribed drug (determined without regard to whether such drug is available without a prescription) or is insulin.  Accordingly, under this new Section, expenses incurred for medicines or drugs may be paid or reimbursed by an employer-provided plan, including a health FSA or HRA, only if it:

(1)        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.

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 employer’s plan.

The Affordable Care Act also amends Section 223(d)(2)(A) with respect to HSAs and Section 220(d)(2)(A) with respect to Archer MSAs, to provide that for amounts paid after December 31, 2010, a distribution from an HSA or Archer MSA for a medicine or drug is a tax-free qualified medical expense only if the medicine or drug is a prescribed drug (determined without regard to whether such drug is available without a prescription) or is insulin.  Accordingly, under these new Sections, a distribution from an HSA or an Archer MSA for a medicine or drug is a tax-free qualified medical expense only if it:

(1)        requires a prescription;
(2)        is an over-the-counter medicine or drug and the individual
            obtains a prescription; or
(3)        is insulin.

If amounts are distributed from an HSA or Archer MSA for any medicine or drug which does not satisfy this requirement, the amounts will be distributions for nonqualified medical expenses, which are includable in gross income and generally subject to a 20% additional tax.  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.

Debit cards

Because of the changes, health FSA and HRA debit card programs cannot reimburse over-the-counter medicines or drugs using an inventory information approval system (“IIAS”) after December 31, 2010.  Such systems must be reprogrammed to reject the use of health FSA or HRA debit cards to purchase such items after that date because an IIAS cannot accommodate the additional level of substantiation needed in order to determine whether the medicine or drug was “prescribed.”

Debit cards may still be used to purchase over-the-counter medicines and drugs at medical care providers by merchant category code and certain qualifying pharmacies.  As in the past, after-the-fact substantiation of the transaction will be required.  However, after the new restrictions take effect, the substantiation must include documentation that the item was “prescribed.” If such documentation is not provided, the transaction will not be properly substantiated.  Participants can also request reimbursement for over-the-counter medicines and drugs by submitting a paper reimbursement request that includes appropriate substantiation.

Cafeteria plan amendments

Under Notice 2010-59, plan sponsors have until June 30, 2011 to amend their cafeteria plans to conform to the new restrictions.  As long as the amendment is adopted no later than June 30, 2011, it 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). 

Notice to employees

Employees should be notified about these changes in advance of the 2011 plan year because they may want to contribute less to their health FSA as a result of the changes.  Health FSAs with a grace period should also let employees know that grace period funds cannot be used to reimburse over-the-counter medicines or drugs incurred after December 31, 2010 unless the items have been prescribed.  These changes should be communicated during open enrollment for the 2011 plan year.

Frequently asked questions

Notice 2010-59 included the following frequently asked questions which shed additional light on the new restrictions. 

Q. How are the rules changing for reimbursing the cost of over-the-counter medicines and drugs from health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs)?

A. Section 9003 of the Affordable Care Act established a new uniform standard for medical expenses.  Effective January 1, 2011, distributions from health FSAs and HRAs will be allowed to reimburse the cost of over-the-counter medicines or drugs only if they are purchased with a prescription.  This new rule does not apply to reimbursements for the cost of insulin, which will continue to be permitted, even if purchased without a prescription.

Q. How are the rules changing for distributions from health savings accounts (HSAs) and Archer Medical Savings Accounts (Archer MSAs) that are used to reimburse the cost of over-the-counter medicines and drugs?

A. In accordance with Section 9003 of the Affordable Care Act, only prescribed medicines or drugs (including over-the-counter medicines and drugs that are prescribed) and insulin (even if purchased without a prescription), will be considered qualifying medical expenses and subject to preferred tax treatment.

Q. When will the changes become effective?

A. The changes are effective for purchases of over-the-counter medicines and drugs without a prescription after December 31, 2010.  The changes do not affect purchases of over-the-counter medicines and drugs in 2010, even if they are reimbursed after December 31, 2010.

Q. How do I prove that I have purchased an over-the-counter medicine or drug with a prescription so that I can get reimbursed from my employer’s health FSA or an HRA?

A. If your employer’s health FSA or HRA reimburses these expenses, you would provide the prescription (or a copy of the prescription or another item showing that a prescription for the item has been issued) and the customer receipt (or similar third-party documentation showing the date of the sale and the amount of the charge).  For example, documentation could consist of a customer receipt issued by a pharmacy that reflects the date of sale and the amount of the charge, along with a copy of the prescription; or it could consist of a customer receipt that identifies the name of the purchaser (or the name of the person for whom the prescription applies), the date and amount of the purchase, and an Rx number.

Q. How does this change affect over-the-counter medical devices and supplies?

A. The new rule does not apply to items for medical care that are not medicines or drugs.  Thus, equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits will still qualify for reimbursement by a health FSA or HRA if purchased after December 31, 2010, and a distribution from an HSA or Archer MSA for the cost of such items will still be tax-free, regardless of whether the items are purchased using a prescription.

Q. Will I need a prescription to use my health FSA, HRA, HSA or Archer MSA funds for insulin purchases after December 31, 2010?

A. No.  You can continue to use your health FSA, HRA, HSA or Archer MSA funds to purchase insulin without a prescription after December 31, 2010.

Q. I use health FSA funds for my co-pays and deductibles.  Will I still be able to reimburse those expenses with health FSA funds after December 31, 2010?

A. Yes.  Co-pays and deductibles continue to be reimbursable from a health FSA after December 31, 2010.  Similarly, funds from an HRA can continue to be used for these expenses and a distribution from an HSA or Archer MSA for these purposes will be tax-free.

Q. My company gives me two extra months beyond the end of the year to submit claims for health FSA expenses incurred during the year.  What happens if I purchase over-the-counter medicines or drugs without a prescription in 2010 but do not submit the claim for those expenses until January 2011? Will they qualify for reimbursement?

A. Yes.  The new restriction on plan reimbursements for the cost of over-the-counter medicines or drugs without a prescription applies only to purchases that are made after 2010.

Q. My company’s health FSA includes a provision for a grace period, so that if I don’t spend all of the money in my health FSA by December 31 in a given year, I can still use the amount left in my health FSA at the end of the year to reimburse expenses I incur during the first 2 1/2 months of the following year.  If I buy over-the-counter medicines or drugs without a prescription during the 2 1/2 month grace period of 2011, can I still use the amount left in my health FSA at the end of 2010 to reimburse those expenses?

A. No.  The change applies to purchases made on or after January 1, 2011.  Thus, even if your employer’s plan includes the 2 1/2 month grace period provision, the cost of over-the-counter medicines and drugs purchased without a prescription during the first 2 1/2 months of 2011 will not be eligible to be reimbursed by a health FSA.

Q. If my plan issues a debit or credit card that I use to pay for over-the-counter medicines or drugs, will I still be able to use the card to purchase over the counter medicines or drugs after December 31, 2010?

A. Generally, no.  The plan must ensure that the card is reprogrammed no later than January 15, 2011 so that the card can no longer be used to purchase over-the-counter medicines or drugs.  For further information, see IRS Notice 2010-59.  If your employer’s plan reimburses expenses for over-the-counter medicines and drugs, you can seek reimbursement for these expenses by presenting the information described above in the answer to the question “How do I prove that I have purchased an over-the-counter medicine or drug with a prescription so that I can get reimbursed from my employer’s health FSA or an HRA?”

Q. If I use HSA or Archer MSA funds to reimburse the cost of over-the-counter medicines or drugs purchased after December 31, 2010 without a prescription, what taxes will I incur?

A. If you have an HSA or Archer MSA, the amount of the distribution for expenses that are not qualifying medical expenses will be includable in your gross income and subject to an additional tax of 20%.

If you have any questions regarding the new over-the-counter drug restrictions or other health care reform changes, you may contact the author of this article or another Snell & Wilmer attorney by calling 602.382.6000.

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