In a Notice, IRS has modified earlier guidance and approved the use of health flexible spending arrangement (FSA) and health reimbursement arrangement (HRA) debit cards, if certain conditions are met, for purposes of substantiating prescribed over-the-counter medicines or drugs under Code Sec. 106(f), added by Sec. 9003 of the Patient Protection and Affordable Care Act (Affordable Care Act, P.L. 111-148, 3/23/2010).
Background. Under Code Sec. 213, expenses for medical care, not compensated for by insurance or otherwise, may be claimed as an itemized deduction to the extent they exceed 7.5% of adjusted gross income (AGI). (For tax years beginning after Dec. 31, 2012, medical expenses will be deductible to the extent they exceed 10% of AGI.) Medical care generally is defined broadly as amounts paid for diagnoses, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure of the body. However, any amount paid during a tax year for medicine or drugs is explicitly deductible as a medical expense only if it is a prescribed drug or is insulin. Thus, any amount paid for non-prescription medicine is not deductible as a medical expense, including any medicine recommended by a physician.
The general definition of medical care without the explicit limitation on medicine applies for the exclusion for employer-provided health coverage and medical care. Thus, under a health FSA or HRA, amounts paid for prescription and over-the-counter medicine are treated as medical expenses, and reimbursements for these amounts are excludible from gross income.
The Affordable Care Act conforms the definition of “medical expense” for purposes of employer-provided health coverage, including FSAs and HRAs, to the definition for purposes of the itemized deduction for medical expenses, except that a prescribed drug is determined without regard to whether it is available without a prescription. The changed definition for health FSAs and HRAs applies for expenses incurred with respect to tax years beginning after Dec. 31, 2010. (Code Sec. 106(f), Code Sec. 220(d)(2)(A), and Code Sec. 223(d)(2)(A), as amended by Affordable Care Act Sec. 9003) Thus, the cost of over-the-counter medicines can't be reimbursed with excludible income through a health FSA or HRA unless the medicine is insulin or prescribed by a doctor.
Notice 2010-59, 2010-39 IRB 396, stated that current health FSA or HRA debit card systems weren't capable of meeting Code Sec. 106(f)’s substantiation requirements for over-the-counter medicines or drugs and generally couldn't be used to purchase over-the-counter medicines or drugs on and after Jan. 15, 2011.
Updated guidance. In Notice 2011-5, IRS says that health FSA and HRA debit cards may continue to be used after Jan. 15, 2011 to purchase and substantiate over-the-counter medicines or drugs at drug stores and pharmacies, at non-health care merchants that have pharmacies, and at mail order and web-based vendors that sell prescription drugs, if:
(1) prior to purchase, (i) the prescription for the over-the-counter medicine or drug is presented (in any format) to the pharmacist; (ii) the over-the-counter medicine or drug is dispensed by the pharmacist in accordance with applicable law and regs; and (iii) an Rx number is assigned;
(2) the pharmacy or other vendor retains, in a manner that meets IRS's recordkeeping requirements: (i) the Rx number; (ii) the name of the purchaser or person for whom the prescription applies; and (iii) the date and amount of the purchase;
(3) all of these records are available to the taxpayer's employer or its agent upon request;
(4) the debit card system won't accept a charge for an over-the-counter medicine or drug unless an Rx number has been assigned; and
(5) additional requirements regarding the use of health FSA or HRA debit cards set forth in Prop Reg § 1.125-6; Rev Rul 2003-43, 2003-1 CB 935; Notice 2006-69, 2006-2 CB 107; Notice 2007-2, 2007-1 CB 254; and Notice 2008-104, 2008-2 CB 1298 are met.
After Jan. 15, 2011, health FSA and HRA debit cards may also continue to be used to purchase over-the-counter medicines or drugs from vendors other than those described above that have health care-related “Merchant Codes” as described in Rev Rul 2003-43, 2003-1 CB 935, including physicians, pharmacies, dentists, vision care offices, hospitals, and other medical care providers. If all other requirements in the preceding paragraph are satisfied, then these debit card transactions will be considered fully substantiated at the time and point-of-sale.
Health FSA and HRA debit cards may also continue to be used to purchase over-the-counter medicines and drugs at “90% pharmacies” with at least 90% of the store's gross receipts during the prior tax year consisting of qualified medical care expenses under Code Sec. 213(d).
Effective date. Notice 2011-5 is effective for health FSA and HRA debit card purchases of over-the-counter medicines or drugs made after Jan. 15, 2011.
Effect on other documents. Notice 2011-5 modifies Notice 2010-59 as it applies to the use of health FSA and HRA debit cards to reimburse expenses for over-the-counter medicines or drugs. IRS and Treasury intend to amend Prop Reg § 1.125-6 to reflect these provisions of this notice. Taxpayers may rely on Notice 2011-5 until the amended regs are issued.
References: For expenditures that qualify as medical care expenses, see FTC 2d/FIN ¶K-2100; United States Tax Reporter ¶2134.04; TaxDesk ¶346,003; TG ¶18800.