Over-the-Counter Medicines – Now Reimbursable
On September 3rd the Treasury Department and IRS released Revenue Ruling 2003-102, which for the first time allows employer-sponsored health plans to reimburse the cost of over-the-counter medicines. This groundbreaking ruling authorizes health flexible spending accounts (“HFSAs”), health reimbursement arrangements (“HRAs”) and other health plans to reimburse expenses for medicines available without a prescription, provided the expense is properly substantiated.
Under the facts of the Ruling, an employee purchased an antacid, an allergy medicine, a pain reliever and a cold medicine for use by the employee, the employee’s spouse and dependents. All of these items were available over-the-counter and without a physician’s prescription. Notwithstanding this, the Ruling holds that all of these items are reimbursable on a tax-free basis by the employer’s health FSA, because they were purchased to alleviate or treat personal injuries or sickness. At the same time, the Ruling holds that “dietary supplements (e.g., vitamins)” purchased without a prescription to maintain general health are not reimbursable on a tax-free basis by the HFSA. Although the Ruling directly addresses HFSA reimbursements, it is interpreting the exclusion for medical reimbursements under Code section 105(b), which governs the tax exclusion for health plan benefits generally. Therefore, its holding will also apply with respect to HRAs and other types of employer health plans.
As part of the Ruling, the IRS distinguishes another recent revenue ruling that held over-the-counter medicines are not deductible under Code section 213(b). The Ruling notes that while a deduction may be claimed only for prescription medicines, this is a special restriction on deductibility, and it does not limit the scope of what is considered “medical care” under section 213. Therefore, section 105(b)’s income exclusion for reimbursements of section 213 medical care expenses extends to non-prescription drugs.
The Ruling contains no special effective date. Therefore, as an interpretation of existing law, it should apply even to expenditures made before its release date. In the case of a plan document that uses a general reimbursement standard (e.g., an HFSA that promises to reimburse all expenses that qualify under section 105(b)), it appears the Ruling would cause the plan automatically to cover over-the-counter medicines back for all open periods. In plans that have expressly excluded over-the-counter medicines, employer sponsors will need to decide whether to allow reimbursement of over-the-counter drug expenses and when any change should be effective. In these cases, allowing reimbursement will require a plan amendment. However, even in these cases, it arguably may be possible to maximize the reduction in employees’ use-it-or-lose-it risk for the current year by amending the HFSA to cover over-the-counter drug expenses back to the beginning of the current period of coverage (usually the current plan year). Still, the need for substantiation will provide a practical limit on retroactive application of the Ruling.
In the HFSA context, where all or most of the plan money is provided by employees, the decision whether to cover over-the-counter drugs primarily presents administrative considerations, i.e., the feasibility of distinguishing over-the-counter drugs from items like vitamins that only support general good health, and the ability to document what was actually purchased. The current practice of reimbursing only prescription drugs arguably offers the advantage of providing a bright-line administrative standard and a ready basis for substantiation.
Outside the HFSA context, considering whether to cover nonprescription drugs under other health plans has real cost implications. For employers struggling to deal with recent increases in health plan costs, coverage for over-the-counter drugs seems unlikely to occur quickly. Still, over time, the Ruling will put pressure on employers to cover certain nonprescription drugs because they will no longer be able to say that IRS prohibits it. In particular, it may cause particular employers to revisit recent decisions that eliminated coverage for certain prescription drugs that are considered comparable to nonprescription alternatives. In addition, if these plan revisions are made during the year, this may permit employees to make a mid-year change in their coverage if the coverage is “significantly improved” as provided under IRS rules. So far there has been no indication from the IRS whether this could constitute a significant improvement in coverage. (However, this mid-year change rule would not apply to plan changes for HFSAs.)
The Ruling’s accompanying press release reflects that the Ruling was sparked by the conversion to over-the-counter status of a number of popular prescription medicines. Because these drugs usually are not covered by general health plans, the Administration views the ruling as a boon to employees by making HFSA tax savings available for these expenses. In addition, to the extent that that HFSAs generally begin to cover these drugs while regular health plans still do not, the Ruling is also a major boost to the importance of HFSAs. In short, viewing the Ruling in conjunction with the recent favorable guidance on HFSA debit cards, it is apparent the regulatory environment for HFSAs has become more hospitable. Credit the current Administration and credit the fact that federal employees now have HFSAs.