Guest Article

(From the September 13, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Guidance Illustrates When Expenses Are Paid for "Medical Care"

Two recently released IRS Information Letters illustrate the analysis that applies in determining when expenses are paid for "medical care" under Code § 213(d) so as to be deductible or eligible for payment by a health care flexible spending account.

Code § 213(d) currently provides a deduction for medical care expenses that exceed 7.5 percent of adjusted gross income. Health care flexible spending account funds must generally be used for medical care expenses as defined in Code § 213(d). "Medical care" expenses are defined in Code § 213(d)(1) as 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. Treasury Regulations further require that the expenditure not be "merely beneficial" to an individual's general health, but must be "primarily for" the prevention or alleviation of a physical or mental defect or illness. (Under the Patient Protection and Affordable Care Act, the 7.5 percent floor in Code § 213(d) is slated to increase to 10 percent beginning in 2013, and reimbursements under health care flexible spending accounts for medicine and drugs are restricted to prescribed drugs and insulin 2010 beginning in 2011.)

In Information Letter 2010-0129, the IRS was asked whether the costs of buying, training, and maintaining a service animal to assist an individual with mental health disabilities would qualify as a "medical care" expense under Code § 213(d). In applying the requirements, the IRS advised that whether an expenditure is "primarily for" medical care is a question of fact that is determined on a case-by-case basis. When expenses of a "peculiarly personal nature" are claimed to be primarily for medical care, the burden is on the taxpayer to establish its claim, the IRS explained. Objective factors are considered, such as the taxpayer's motive or purpose in making the expenditure, whether a physician diagnosed a condition and recommended the item as treatment, the link between the treatment and the illness, the effectiveness of the treatment, and the proximity in time to the occurrence of the disease. A "but for" test also applies: the taxpayer needs to establish that the expense would not have been paid if not for the disease or illness. If the taxpayer would have paid the expense even in the absence of a medical condition, the expense is not for medical care. All said, the IRS concluded that the costs of buying, training and maintaining a service animal could qualify as Code § 213(d) medical care expenses if the taxpayer met the enumerated proofs.

In Information Letter 2010-0080, the IRS was asked whether the cost of an herb prescribed by the taxpayer's doctor to treat migraine headaches would qualify as a "medical care" expense under Code § 213(d). Applying the same analysis, the IRS advised that naturopathic care, including herbs, can qualify as medical care under Code § 213(d). The cost of an herb could qualify as a Code § 213(d) medical care expense if the taxpayer substantiates that she has a medical condition (i.e., disease, illness or injury), is purchasing the herb to treat or alleviate the medical condition, and would not have purchased the herb "but for" the medical condition. The analysis was similar to the IRS's reasoning in earlier IRS Information Letter 2001-0297, which addressed whether the cost of cayenne pepper, recommended by a naturopathic physician as a treatment for Raynaud's disease, would qualify as a medical care expense.

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, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2010, Deloitte.