Subscribe (Free) to
Daily or Weekly Newsletters

Post a Job

Featured Jobs

DWC ERISA Consultants LLC
(Remote)

Retirement Plan Administrator

Compensation Strategies Group, Ltd.
(Remote)

Census Coordinator

BPAS
(Utica NY / Hybrid)

Defined Benefit Specialist II or III

Nova 401(k) Associates
(Remote)

Client Service Specialist

EPIC RPS
(Remote / Norwich NY)

Plan Installation Manager

July Business Services
(Remote / Waco TX)

Regional Sales Consultant

The Pension Source
(AL / AR / GA / KY / MS / TN / TX)

Senior Plan Administrator

Merkley Retirement Consultants
(Remote)

Omni Operator

BPAS
(Utica NY)

Distributions Processor - Qualified Retirement Plans

Anchor 3(16) Fiduciary Solutions, LLC
(Remote / Wexford PA)

Retirement Combo Plan Administrator

Heritage Pension Advisors, Inc.
(Remote / Commack NY)

Implementation Specialist

Nova 401(k) Associates
(Remote)

View More Employee Benefits Jobs

Free Newsletters

“BenefitsLink continues to be the most valuable resource we have at the firm.”

-- An attorney subscriber

Guest Article

(From the December 15, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Extends Transition Relief for Using Health FSA and HRA Debit Cards at Drug Stores and Pharmacies

The IRS has issued Notice 2008-104 to extend by six months the transition relief for using health flexible spending arrangement (Health FSA) and health reimbursement arrangement (HRA) debit cards at certain merchants with Drug Store and Pharmacy merchant category codes (MCCs). (The notice does not address using debit cards with health savings accounts (HSAs), which are subject to different rules.) Basically, the notice gives these merchants until June 30, 2009 -- instead of December 31, 2008 -- to implement the inventory information approval system described in Notice 2006-69, 2006-31 I.R.B. 107.

Background

In general, employers can reimburse employees, their spouses, and dependents, for medical care expenses on a tax-free basis. IRC § 105(b). Employers may use Health FSAs, HRAs, or other plan designs to provide these reimbursements. Usually, employers offer Health FSA's through IRC § 125 cafeteria plans so employees can fund them with pretax salary reduction contributions. Employers cannot offer HRAs through IRC § 125 plans, and HRAs may not be funded with employee contributions of any kind.

For this special tax treatment to apply, the employer's plan must satisfy a number of conditions. For example, the plan must limit reimbursements to expenses incurred for "medical care" as defined by IRC § 213(d) (generally, amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body). The plan also must have a procedure in place for substantiating all reimbursement claims, among other things.

Whether a Health FSA, HRA, or some other plan design is used, the plan usually does not reimburse expenses until the participant substantiates them with the appropriate documentation, such as a receipt. That way, it is not possible for the plan's money to be used for any purpose other than reimbursing valid medical expenses incurred by participants, their spouses, and their dependents. Debit-type cards give Health FSA and HRA participants more flexibility, but they also have the potential to make it easier for participants to use their benefits improperly in the absence of appropriate substantiation procedures. This, in turn, could endanger the plan's tax-favored status under IRC § 105(b).

If a Health FSA or HRA fails to satisfy IRC § 105(b)'s requirements, then all reimbursements from the plan -- including reimbursements for medical expenses -- are taxable to the recipient.

Using Debit Cards with Health FSAs and HRAs

The IRS previously issued Rev. Rul. 2003-43, 2003-1 C.B. 935, on using cards to reimburse participants in health FSAs and HRAs. That revenue ruling focused on properly substantiating expenses paid with cards, and specified some appropriate -- and inappropriate -- substantiation procedures. Specifically, Rev. Rul. 2003-43 established the following procedures for substantiating claimed medical expenses paid from health FSAs or HRAs with debit, credit, or stored value cards:

If the dollar amount of the transaction at a health care provider equals the dollar amount of the copayment for that service under the accident or health plan (i.e., the major medical plan, health maintenance organization, etc.) covering the specific employee-cardholder, the charge is fully substantiated without the need for submission of a receipt or further review (i.e., copayment match).
The employer permits automatic reimbursement without further review of recurring expenses that match expenses previously approved as to amount, provider, and time period (i.e., recurring expenses).
If the merchant, service-provider, or other independent third-party (e.g., Pharmacy Benefit Manager), at the time and point-of-sale, provides information to verify to the employer (including electronically by e-mail, the Internet, intranet, or telephone) that the charge is for a medical expense, the charge is fully substantiated without the need for submission of a receipt or further review (i.e., real-time substantiation).
All other charges to the card are treated as conditional pending confirmation by submission of a receipt or other third-party information (aka, "pay and chase").

Significantly, the holding in Rev. Rul. 2003-43 is limited to cases in which the debit card can be used only at merchants and service providers that have MCCs related to health care, such as physicians, pharmacies, dentists, vision care offices, hospitals, and "other medical care providers." For merchants and service providers with non-health care related MCCs, Notice 2006-69 introduced an inventory information approval system that can be used to avoid post-transaction substantiation or review of Health FSA or HRA debit card transactions. The notice describes the inventory information approval system as follows:

Under this method, when an employee uses the card, the merchant's system collects information about the items purchased using the inventory control information (e.g., SKUs). The system compares the inventory control information for the items purchased against a list of items, the purchase of which qualifies as expenses for medical care under § 213(d) (including nonprescription medications as described in Rev. Rul. 2003-102, 2003-2 C.B. 559). The § 213(d) medical expenses are totaled and the merchant's or payment card processor's system approves the use of the card only for the amount of the § 213(d) medical expenses subject to coverage under the health FSA (taking into consideration the uniform coverage rule) or HRA. If the transaction is only partially approved, the employee is required to tender additional amounts, resulting in a split tender transaction.

The notice illustrates this system with the following example:

Example. Employer Y reimburses health FSA claims through debit cards, as described in Situation 1 of Rev. Rul. 2003-43. Y has adopted the inventory information approval system. Several stores that do not have health care related merchant category codes participate in the system (i.e., participating merchants). These participating merchants sell nonprescription medications. The use of the card has been expanded to include the participating merchants.
Employee C is a participant in the health FSA sponsored by Employer Y and has $100 of health FSA coverage. Y's health FSA covers nonprescription medications. C purchases aspirin, antacid, and cold medication for C and C's spouse and dependents at one of the participating merchants. The total amount for these medical expenses is $20.75. At the same time, C also purchases $50.00 of items that do not qualify as medical expenses under § 213(d), for a total purchase amount of $70.75. The store's system compares the SKUs from all of the items against the SKUs from a list of items that qualify as medical expenses under § 213(d). The charge for the medical expenses totaling $20.75 is authorized and the remaining $50.00 is rejected. Employee C is asked for additional payment to purchase the remaining non-medical items.

Stores with Drug Stores and Pharmacies MCCs

Rev. Rul. 2003-43 permits use of Health FSA and HRA debit cards at stores with the MCC for Drug Stores and Pharmacies. However, because these stores often sell lots of non-medical items, the IRS has determined additional safeguards are needed to ensure these debit cards are used only for medical expenses. Thus, Notice 2007-2 provided Health FSA and HRA debit cards can be used at stores with Drug Stores and Pharmacies MCC after December 31, 2008 only if --

The store participates in the inventory approval system described in Notice 2006-69; or
On a store by store location basis, 90 percent of the store's gross receipts during the prior taxable year consisted of items which qualify as IRC § 213(d) medical expenses.

Notice 2008-104 extends the December 31, 2008 deadline by six months, until June 30, 2009.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595 Deborah Walker 202.879.4955.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.