IRS guidance on FSA and HSA reimbursements for OTC drugs.

• Author: Dell, Michael
• Position: Flexible spending account, health savings account, over-the-counter drugs

The IRS has issued guidance (Notice 2010-59 and Rev. Rul. 2010-23) implementing the Patient Protection and Affordable Care Act's prohibition on reimbursement of the cost of over-the-counter (OTC) drugs by health savings accounts (HSAs), health retirement accounts (HRAs), Archer medical savings accounts (MSAs), and flexible spending accounts (FSAs). The prohibition, which is effective January 1, 2011, allows reimbursement for an OTC drug only if the individual has a prescription for the drug.

Background

Current law permits various individual health account arrangements to reimburse for moneys spent on OTC drugs such as aspirin as well as prescription drugs. The rules governing such reimbursements are specified in Rev. Rul. 2003-102. The Patient Protection and Affordable Care Act, P.L. 111-148 (PPACA), prohibits FSAs and HSAs from reimbursing a participant for the purchase of OTC drugs unless the participant has a prescription for the OTC drug (even though a prescription is not needed to obtain the drug).

Some FSAs and HRAs provide participants with health debit cards to use for the purchase of covered medical items. The rules for the use of debit cards are set forth in Prop. Regs. Sec. 1.125-6, Rev. Rul. 2003-43, and Notices 2006-69, 2007-2, and 2008-104. These rules allow the use of health debit cards at merchants that have an inventory information approval system or at a pharmacy where 90% of the store's gross receipts during the prior tax year consist of items that qualify as medical expenses under Sec. 213(d).

New Guidance

The IRS issued Rev. Rul. 2010-23, which makes Rev. Rul. 2003-102 obsolete, to explain how the new restrictions will apply beginning on January 1, 2011. Under the PPACA change, the Code will allow tax-free reimbursement only if the drug (1) requires a prescription, (2) does not require a prescription but the individual has a prescription for it, or (3) is insulin. Amounts distributed to FSA or HSA participants for purchases that do not satisfy one of these requirements will be includible in the participants' gross income and are generally subject to an additional 20% tax.

Notice 2010-59 defines a prescription as a written or electronic order for a medicine or drug that meets the legal requirements of a prescription in the state where the expense is incurred and is issued by a legally authorized individual. The prescription rule does not apply to equipment such as crutches, supplies such as bandages, and diagnostic...