Revisions regarding OTC Drugs Effective 1/16/11

The Internal Revenue Service on Dec. 23, 2010, issued IRS Notice 2011-5allowing the continued use of health flexible spending account (FSA) and health reimbursement arrangement (HRA) debit cards for the purchase of over-the-counter (OTC) medicines and drugs for which the taxpayer has obtained a prescription.

The guidance does not address health savings account (HSA) debit cards, in part because FSA and HRA purchases must be substantiated at the point of sale while HSA purchases are self-substantiated, with documentation saved by the purchaser and presented in the event of an IRS audit; inappropriate or "nonqualified" HSA distributions would then be subject to income tax plus a 20 percent penalty.

However, the accompanying frequently asked questions issued by the IRS note that under the Patient Protection and Affordable Care Act "only prescribed medicines or drugs…and insulin (even if purchased without a prescription) will be considered qualifying medical expenses and subject to preferred tax treatment" for FSAs, HRAs and HSAs.

New Procedures:

Effective Jan. 16, 2011, in accordance with the guidance, the use of FSA and HRA debit cards to purchase OTC medications must comply with procedures reflecting those that pharmacies (as well as mail-order and web-based vendors) follow when selling prescribed medicines or drugs. These include requirements that:

• Prior to purchase, the prescription for the OTC medicine or drug is presented to the pharmacist or other authorized vendor.
• The OTC medicine or drug is dispensed in accordance with applicable law and regulations.
• The debit card system does not accept a charge for an OTC medicine or drug unless an Rx number has been assigned.
• The pharmacy or other vendor retains a record of the prescription number, the name of the purchaser (or the name of the person for whom the prescription applies), and the date and amount of the purchase.
• All of these records are available to the employer or its agent on request.

If all requirements are met, the debit card transaction will be considered fully substantiated at the time and point of sale.

In addition, the guidance clarifies that:

• The prescription requirement applies to OTC medicine and drug purchases made on or after Jan. 1, 2011, and not to purchases made in 2010 even if reimbursed after Dec. 31, 2010.(As noted above, Jan. 16, 2010 is the date on which FSA and HRA debit card over-the-counter purchases must comply with all point of sale substantiation procedures.)
• The requirement applies only to OTC medications. It does not apply to other health care expenses such as medical devices, eyeglasses and contact lenses.