Over-the-Counter Drugs May Now Be Reimbursable
September 17, 2003
Over-the-Counter Drugs May Now Be Reimbursable
On September 3, 2003, the IRS released Revenue Ruling 2003-102, which provides that over-the-counter drugs may be reimbursed by health flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs) and other employer-sponsored health plans. The groundbreaking ruling revises the IRS’ long-standing position that reimbursements of over-the-counter, nonprescription drugs are included in taxable income.
Internal Revenue Code Section 105(b) provides an exclusion from income for reimbursements paid under an employer-provided accident and health plan for expenses incurred by an employee for medical care. For many years, the IRS informally took the position that reimbursements of expenses for over-the-counter drugs were not excludable under Code Section 105(b) because these drugs are not deductible under Code Section 213(b). As a result, many employer-sponsored health plans did not reimburse expenses for over-the-counter drugs. But the IRS has now clarified that reimbursement of expenses for over-the-counter drugs may be excluded under Code Section 105(b) as long as the drugs satisfy the definition of medical expenses in Code Section 213(d).
Drugs That May Be Reimbursed
The ruling provides that reimbursement by an employer of amounts paid by an employee for medicine and drugs purchased by an employee without a physician’s prescription are excludable from gross income under Code Section 105(b), provided they alleviate or treat personal injuries or sickness of the employee or the employee’s spouse or dependents. The ruling specifically approves the tax-free reimbursement of expenses incurred by an employee for antacid, allergy medicine, pain reliever and cold medicine without a physician’s prescription.
Drugs That May Not Be Reimbursed
The ruling does not permit the tax-free reimbursement of dietary supplements (i.e., vitamins) that are “merely beneficial to the general health” of the employee or the employee’s spouse or dependents. In order to be reimbursable on a tax-free basis, dietary supplements must be purchased to alleviate or treat personal injuries or sickness, not to maintain general good health.
Implications for Plans
The new ruling will prompt many plan sponsors to consider reimbursing over-the-counter medicine and drugs under their health plans. The ruling does not require plan sponsors to reimburse over-the-counter drugs. Some sponsors may choose to permit reimbursement under all of their health plans and others may choose to limit reimbursement to health FSAs. In any event, sponsors will need to review their plan documents, summary plan descriptions and reimbursement forms to ensure that these documents accurately reflect the sponsor’s intent.
Another consideration is the effective date. The ruling does not specify an effective date, and sponsors who wish to reimburse over-the-counter drugs will need to consider whether to permit reimbursement prospectively or retroactively. Although the IRS generally frowns on retroactive welfare plan changes, there may be reasonable arguments to support implementing reimbursement of over-the-counter drugs retroactively to the beginning of the plan year. But retroactive implementation will raise administrative issues, including substantiation of expenses and coordination with third-party administrators and communication with plan participants. To avoid these administrative issues, many sponsors will choose to implement reimbursement of over-the-counter drugs prospectively.
The ruling does not provide details regarding the types of medicine and drugs that may be reimbursed, nor does it discuss substantiation requirements for medicine and drugs not prescribed by a physician. Before implementing reimbursement of these drugs, plan sponsors should discuss these issues with their third-party administrators. Plan sponsors may also wish to consider implementing reasonable claim filing requirements (such as a $50 minimum) to help manage the volume of over-the-counter drug claims. In addition, plan sponsors who decide to reimburse over-the-counter drugs will need to communicate the details of their reimbursement approach to plan participants.
The ruling presents plan sponsors with a valuable opportunity to expand the attractiveness of health FSAs. By permitting reimbursement of the cost of over-the-counter drugs on a tax-free basis, the ruling provides a way for employees to reduce their non-prescription drug costs. In addition, the ruling provides another means to help employees spend down their FSA account balances and avoid year-end forfeitures. At the same time, plan sponsors will not want to permit reimbursement of over-the-counter drugs without considering the impact on plan administrative costs.
