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IRS Issues New Guidance on PPACA Changes to OTC Medical Expenses


The Internal Revenue Service issued guidance last Friday, September 3, 2010, in the form of Notice 2010-59 that reflects statutory changes regarding the use of health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs) to pay for over-the-counter medicines and drugs.  A copy of the IRS Notice is attached for your convenience.  This guidance is reproduced below at the end of this email and is scheduled to be published on September 27, 2010. PPACA revised the definition of medical expenses for employer-provided accident and health plans, including health FSAs and HRAs.  PPACA also revised the definition of qualified medical expenses for Health Savings Accounts (HSAs) and Archer Medical Savings Accounts (Archer MSAs).  Beginning after December 31, 2010, expenses incurred for medicines or drugs may be paid or reimbursed by an employer-provided plan, including a health FSA or HRA, only if
  • the medicine or drug requires a prescription,
  • is available without a prescription (an over-the-counter medicine or drug) and the individual obtains a prescription, or
  • is insulin.
A “prescription” means a written or electronic requirements of a prescription in the state in which the medical expense is incurred and that is issued by an individual who is legally authorized to issue a prescription in that state.  Expenses incurred for over-the-counter medicines or drugs purchased without a prescription before January 1, 2011 may be reimbursed tax-free at any time, pursuant to the terms of the employer's plan. There are special rules for FSAs or HRAs using a debit card.  The Notice indicates that current debit card systems are not capable of substantiating compliance with the revised definition of medical expense with respect to over-the-counter medicines or drugs because the systems are incapable of recognizing and substantiating that the medicines or drugs were prescribed. Therefore, for medical expenses incurred on and after January 1, 2011, health FSA and HRA debit cards may not be used to purchase over-the-counter medicines or drugs. In order to facilitate the significant changes to existing systems necessary to reflect the statutory change, the IRS will not challenge the use of health FSA and HRA debit cards for expenses incurred through January 15, 2011.  However, the plan must ensure that the card is reprogrammed no later than January 15, 2011 so that the card can no longer be used to purchase over-the-counter medicines or drugs. Some health FSAs include a provision for a grace period, so that if all of the money in the health FSA is not spent by December 31 in a given year, the amount left in the health FSA can still be used at the end of the year to reimburse expenses incurred during the first 2 1/2 months of the following year. The IRS Notice makes it clear that the new OTC rules apply to purchases made on or after January 1, 2011. Thus, even if the FSA plan includes a 2 1/2 month grace period provision, the cost of OTC medicines and drugs purchased without a prescription during the first 2 1/2 months of 2011 will not be eligible to be reimbursed by a health FSA. Finally, cafeteria plans may need to be amended to conform to the new OTC requirements. Notwithstanding the rule against retroactive amendments, Notice 2010-59 permits an amendment to conform a cafeteria plan to the requirements set forth in the Notice that is adopted no later than June 30, 2011.  The amendment may be made effective retroactively for expenses incurred after December 31, 2010 (or after January 15, 2011 for health FSA and HRA debit card purchases). Please contact me if you have any questions. Richard A. Szczebak, Esq. | Of Counsel | Parker Brown & Macaulay, P.C.  4 Faneuil Hall Marketplace, Boston MA 02109 | 617-399-0441 | Fax 617-350-7744 rszczebak@parkerbrown.com | www.parkerbrown.com Treasury Regulations (Circular 230) require us to disclose the following in connection with the correspondence: Subject to the exclusions specified in Circular 230, any advice included in this email and its attachments regarding federal tax matters was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

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