To the relief of many employers, the Internal Revenue Service (IRS) recently approved the use of credit or debit cards in connection with reimbursing employees for eligible medical expenses under qualifying health care reimbursement arrangements. The IRS guidance, Revenue Ruling 2003-43, illustrates how to implement a credit or debit card reimbursement program in connection with a health reimbursement arrangement (HRA) or health care flexible spending account (FSA). The guidance also explains what types of programs are impermissible.
Traditional HRAs and FSAs
Under traditional HRAs and FSAs, an employee typically pays for medical expenses and then submits receipts to either the employer or a third-party administrator to obtain reimbursements. Although the paperwork can be cumbersome, it enables the employer to substantiate whether the employee actually incurred the expense and whether it is eligible for reimbursement under Section 213(d) of the Internal Revenue Code (the Code). This substantiation is required so the employee may exclude reimbursement amounts from income. Several companies already market debit or credit card services in connection with HRAs and FSAs. However, employers have been concerned as to whether debit or credit card programs meet the Code’s substantiation requirements. The new guidance addresses some of the confusion surrounding this type of HRA and FSA funding.
Establishing a Permitted Credit or Debit Card Reimbursement Program
The IRS specifically approved the following method for implementing a credit or debit card reimbursement program:
- Employee Certification: A credit or debit card is issued to each covered employee. Upon enrollment in the FSA and/or HRA and each plan year afterwards, the employee certifies that the credit or debit card will only be used to pay for eligible medical care expenses for the employee and his or her spouse or dependents and the expenses paid with the card have not been and will not be reimbursed by another health plan. The credit or debit card should have similar certification language printed on the back of the card.
- Document Retention: The employee cardholder agrees to acquire and retain documentation for any expense paid with the card, e.g., invoices and receipts.
- Limited Amount: The use of the credit or debit card is limited to the maximum dollar amount of coverage available in the employee’s FSA or HRA. When the card is used, the merchant or service provider is paid the full amount of the charge (not to exceed the account balance), and the employee’s FSA or HRA is reduced by the same amount.
- Limited Use: The card only works at certain merchant or service providers authorized by the employer, and use of the card is limited to specified merchant codes that relate to health care: physicians, pharmacies, dentists, vision care offices, hospitals and other medical care providers. The card is automatically cancelled when the employee terminates employment.
- Reporting Requirements: The IRS requires that payments made to medical service providers through the use of debit or credit card programs be reported by the employer to the recipient of the reimbursements on a Form 1099-MISC. Generally, this reporting requirement applies if payments of $600 or more are reimbursed to any single provider. However, certain exceptions could apply for payments to tax-exempt hospitals, for example.
Permitted Expense Substantiation Requirements
For an amount paid as a medical expense reimbursement to be properly excluded from an employee’s gross income, the claimed medical expense must be substantiated as an eligible medical expense under the Code Section 213(d). This substantiation requirement is met under debit or credit card funding where the following procedures are implemented:
- Copayment: If the dollar amount of the charge from the health care provider is the same as the dollar amount of the copayment for that service under the employee’s health plan, the charge meets the substantiation requirements without need for further review (for example, a $15 charge at a physician’s office where there is a $15 copay required for such visits).
- Recurring Expenses: If the employee charges an expense that matches a previously approved expense with respect to amount, provider and time period, the charge meets the substantiation requirements without need for further review (for example, an employee who refills a prescription on a regular basis using the same pharmacy).
- Real-Time Substantiation: If the merchant, service provider or other independent third-party at the time and point of sale provides information to the employer verifying that the charge is for an eligible medical expense, the charge meets the substantiation requirements without need for further review (for example, the physician’s office is prompted to enter a code for the type of treatment when charges in excess of the copayment amount are authorized).
- All Other Charges: The employer requires that all other charges be treated as conditional, pending confirmation of the charge. Additional information must be submitted for review and substantiation of these charges, describing the service or product, the date of the service or sale and the amount of the charge.
- Claims Not Charged: The employer allows employees to submit claims for reimbursement under their FSAs or HRAs without the use of the credit or debit card, by the employee’s submission of either an Explanation of Benefits received from a health insurance provider or a receipt from a merchant or service provider showing that the employee paid for or owes amounts for eligible medical expenses. The employer may either pay the merchant or service provider directly or, where the employee supplies documentation that he or she has paid the charge, may reimburse the employee.
Inadequate Expense Substantiation Requirements
Revenue Ruling 2003-43 also describes methods of substantiation that are specifically disallowed as inadequate to meet the claim substantiation requirement under Code Sections 125 and 105. "Sampling" methods, where an employer reviews a certain percentage of claims based upon amount or provider type, are not sufficient because the Code requires that each reimbursed claim be substantiated. Likewise, an amount-based method does not meet the substantiation requirement where claims under a certain dollar amount or for a multiple of a specified whole-dollar amount are not reviewed under the assumption that all such amounts are copayments.
Correction Method for Improper Payments
If a reimbursed claim is later discovered to have been ineligible for reimbursement, Rev. Proc. 2003-43 establishes an acceptable correction method. This correction method may be relevant to correcting regular FSA reimbursement errors as well (although Rev. Proc. 2003-43 did not so specifically state.) The IRS approved the following correction method:
- Once an improper payment is identified, the employer requires the employee to reimburse the health plan for the improper payment.
- If the employee does not repay the health plan, the employer withholds the amount of the improper payment from the employee’s wages or other compensation to the extent consistent with applicable law.
- If an employer is unable to obtain repayment from the employee or withhold the improper payment from other wages or compensation, the employer must use a claims substitution or offset approach; for example, the employer does not reimburse the employee for subsequent claims made during the same coverage period until the improper payment amount has been repaid.
- In addition to the above three steps, the employer takes other actions to ensure that further violations of the terms of the credit or debit card do not take place, including denial of access to the card until indebtedness is repaid by the employee.
If this correction method is unsuccessful or unavailable, under Rev. Rul. 2003-43 the IRS allows the employer to treat the employee’s indebtedness as it would any other business indebtedness.
Implications for Employers
In light of the newly released IRS guidance, it is anticipated that more employers will be implementing credit or debit card based reimbursement systems, and employee participation in these programs will be greater due to increased convenience. Those employers who have already implemented credit or debit card programs should review these programs and any vendor contracts carefully to make sure that they comply with the new IRS guidance. In addition, employers who either have these programs or would like to implement these programs should consider the tax reporting requirements for reimbursements through the use of debit or credit cards. Failure to meet the IRS-approved standards could result in adverse tax consequences to both employers and employees.