As explained in our 2010 4th Quarter Benefits & Employment Briefing, last year's Affordable Care Act (ACA) restricted the ability of employer health plans, including flexible spending arrangements (FSAs) and health reimbursement arrangements (HRAs), to reimburse expenses incurred for over-the-counter (OTC) medications. With the exception of insulin, expenses for OTC medications may now be reimbursed only if the medications are prescribed by a physician. Sponsors of FSAs face a June 30 deadline for amending their plans to comply with this ACA restriction.
This restriction actually became effective as of January 1, 2011. Ordinarily, the IRS requires that FSA amendments be adopted before they take effect. Moreover, proposed IRS regulations state that any failure to satisfy this requirement results in all employee contributions to the FSA becoming taxable. Perhaps recognizing the severity of this result, the IRS in Notice 2010-59 granted FSA sponsors an additional six months to adopt amendments designed to comply with this restriction. That six-month extension expires on June 30, 2011.
A similar restriction applies to the reimbursement of expenses for OTC medications under health savings accounts (HSAs) and Archer Medical Savings Accounts (MSAs). However, the consequences of non-compliance under such arrangements differ from those that apply under FSAs or HRAs. Distributions from an individual's HSA or MSA for OTC medications that are not prescribed by a physician are treated as "nonqualified" distributions. They are therefore includible in the individual's taxable income, and also subject to a 20% penalty tax. In any event, because most HSAs and MSAs are maintained on documents provided by financial institutions, employers will generally rely on those institutions to adopt timely amendments complying with this ACA restriction.
In drafting amendments to their FSAs or HRAs, employers will want to keep in mind several key points. First, such an amendment should be retroactively effective as of January 1, 2011. This date applies regardless of an arrangement's plan year, and even if an FSA has been amended to take advantage of the 2 ½ - month "grace period" allowed by the IRS. However, any expenses for OTC medications that were incurred before January 1, 2011, may still be reimbursed after that date, even without a prescription.
Another point to be addressed in any FSA or HRA amendment involves the treatment of OTC items other than medications. Notice 2010-59 made clear that expenses for equipment (such as crutches), supplies (such as bandages), and diagnostic devices (such as blood sugar test kits) may still be reimbursed under an FSA or HRA, even without a prescription. In other words, the prescription requirement applies only to OTC medications. (As under longstanding law, however, expenses for items that are merely beneficial to the general health of an individual - such as toiletries - may not be reimbursed from these arrangements.)
Finally, any amendment to an FSA or HRA that allows participants to use debit cards to purchase OTC medications should take into account additional IRS guidance. For instance, Notice 2010-59 granted such arrangements an additional fifteen days (through January 15, 2011) to comply with the requirement of a physician's prescription for an OTC medication. IRS Notice 2011-5 then outlined specific procedures that must be followed if debit cards will continue to be an option for the purchase of OTC medications after January 15, 2011. In general, these procedures are designed to ensure that these cards can be used to purchase OTC medications only after a prescription has been obtained.
Commonwealth Benefits Group would be pleased to assist employers in adopting timely FSA or HRA amendments that comply with all of these requirements.
Kenneth A. Mason, Partner
Spencer Fane Britt & Browne LLP