Guest Article

(From the January 10, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

New Guidance Permits Use of Debit Cards to Buy OTC Drugs after January 15

The IRS modified its earlier position that prohibited the purchase of over-the-counter drugs with a health FSA or HRA debit card after January 15, 2011 because of new provisions in the Patient Protection and Affordable Care Act. A new IRS Notice now allows prescribed over-the counter drugs and medicines to be purchased with the debit cards if certain requirements are met.

The Patient Protection and Affordable Care Act (PPACA) changed the definition of "medical expenses" that are eligible for reimbursement by health flexible spending arrangements ("health FSAs") and health reimbursement arrangements ("HRAs"), or tax-favored treatment under health savings accounts and Archer medical savings accounts. The PPACA provides that, after December 31, 2010, over-the counter ("OTC") drugs and medicines will no longer qualify as "medical expenses" unless they are insulin or are prescribed.

In preparation for this change, in September 2010 the IRS issued a Notice explaining that, because the purchase of an OTC drug or medicine will be reimbursable only if it is substantiated as a medical expense (which, for purchases after 2010, would require proof that it was prescribed) - and the current debit card systems are not capable of substantiating that OTC drugs or medicines are prescribed - then health FSA or HRA debit cards could not be used to purchase OTC drugs or medicines. (Rather, the claim would need to be submitted with the necessary proof of prescription in order for the individual to be reimbursed for the medical expense.) The general prohibition became effective January 1, 2011, but a transition period was granted through January 15, 2011 during which time the continued use of debit cards to purchase OTC drugs and medicines would not be challenged as long as the purchases were consistent with the IRS's previously-issued guidance.

Despite the general prohibition, the September 2010 Notice specifically allowed the use of debit cards to purchase OTC drugs and medicines at pharmacies that satisfy the 90-percent test - that is, pharmacies at which 90 percent of the gross receipts during the prior taxable year consisted of items that qualified as medical care under Code § 213(d) - if the necessary substantiation (including the prescription) is properly submitted by an independent third-party.

Notice 2011-5

Newly issued IRS guidance - Notice 2011-5 - modifies the government's earlier position and allows health FSA and HRA debit cards to be used after January 15, 2011 to purchase prescribed OTC drugs or medicines if certain requirements are met. The purchases can made by debit card, and considered fully substantiated at the point-of-sale:

Also, the debit cards can continue to be used at "90 percent" pharmacies" as provided in the September 2010 notice, described above. For other merchants, the use of health FSA or HRA debit cards to purchase OTC drugs or medicines is prohibited after January 15, 2011. The IRS announced it will be modifying the Treasury Regulations under Code § 125 to incorporate these new provisions.

A helpful set of Frequently Asked Questions was also released explaining the new requirements for OTC drugs and medicines.

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 202.220.2692, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2011, Deloitte.