IRS eases FSA use-it-or-lose-it rule

By Allison Bell
via LifeHealthpro

The Internal Revenue Service (IRS) has decided to let holders of health flexible spending arrangements (FSA) roll over up to $500 in account balance from one year to the next without worrying about the infamous "use-it-or-lose-it" rule."

Officials at the IRS, an arm of the U.S. Treasury Department, have discussed the change in IRS Notice 2013-71, and they also talk in the notice about how they will make the change available to workers at employers with non-calendar plan years.

FSAs give workers a vehicle for setting aside cash to pay for health care expenses without paying income taxes on the cash.

The IRS tried to discourage high-income workers from using FSAs as investment accounts by requiring them to forfeit any unused cash at the end of the plan year. The employers got to keep any cash forfeited.

In 2005, the IRS tried to ease the burden the rule caused by creating a grace period. The grace period rule gave FSA holders the ability to avoid losing FSA cash by using the cash up to two months and 15 days after the end of the plan year.

In 2010, the drafters of the Patient Protection and Affordable Care Act (PPACA) tried to generate revenue to cover part of the cost of PPACA by capping the deductibility of FSA contributions at $2,500 per year.

IRS officials noted in 2012, in Notice 2012-40, that because PPACA capped tax deductible contributions at $2,500 per year, the FSA could no longer be much of a tax shelter for the wealthy.
When officials asked for comments on changing the use-it-or-lose-it rule in that notice, commenters said a change could simplify health FSA administration, and make FSA programs more attractive to low-income and moderate-income workers, who "are more reluctant than others to participate because of aversion to even modest forfeitures of their salary reduction contributions," officials said.
IRS officials said they believe a $500 rollover cap is appropriate because most FSA forfeitures are for less than $500.

An employer cannot offer a FSA carryover provision and an FSA grace period at the same time.
To adopt the change, an employer must add a carryover provision to the FSA plan document and eliminate any grace period provision, officials said.

Despite Veto Threat, House Approves Changes to Use It or Lose It Rule

Defying a presidential veto threat, the House of Representatives on Thursday approved legislation that would ease a 28-year-old Internal Revenue Service rule that requires forfeiture of unused flexible spending account balances and eliminates restrictions on using FSAs and health savings accounts to pay for over-the-counter medications.


Under the measure, approved on a 270-146 vote, employers could amend their FSAs to allow employees to withdraw as taxable cash up to $500 in unused balances remaining at the end of the plan year or at the end of an FSA grace period, if an employer has that feature. In addition, H.R. 436 would overturn a health care reform law provision that bars FSA reimbursement of OTC medications without a prescription and imposes a 20% federal tax on HSA distributions for OTC medications obtained without a prescription.

Senate approval ‘unlikely’


President Barack Obama, though, may not have an opportunity to carry out his veto threat as the Senate may not even take up the proposal, some benefit observers say.“I don’t think the Senate will act,” said J.D. Piro, a senior vp at Aon Hewitt in Norwalk, Conn.Bundling the FSA provisions with the repeal of the excise taxes on medical devices makes the bill’s chances of winning Senate approval “very unlikely,” said Chantel Sheaks, a principal with Buck Consultants L.L.C. in Washington.Giving FSA participants the ability to receive up to $500 of unused balances would have only a modest impact on boosting plan participation and would be somewhat administratively burdensome on employers, Mr. Piro said.


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Obama to Veto FSA/HSA Legislation

WASHINGTON—President Barack Obama will veto legislation that would ease a 28-year-old Internal Revenue Service rule that requires forfeiture of unused flexible spending account balances and eliminates restrictions on using FSAs and health savings accounts to pay for over-the-counter medications, the administration said Wednesday.


Under the measure headed for a vote this week on the House floor, employers could amend their FSAs to allow employees to withdraw as taxable cash up to $500 in unused balances remaining at the end of the plan year or at the end of an FSA grace period, if an employer has that feature. If passed, the measure would be considered by the Senate.

OTC medications

In addition, H.R. 436 would overturn a health care reform law provision that allows FSA reimbursement of OTC medications without a prescription and imposes a 20% federal tax on HSA distributions for OTC medications obtained without a prescription. Those provisions are part of a broader bill, H.R 436, that would repeal a provision from the Patient Protection and Affordable Care Act that imposes new federal excise taxes on medical devices and boosts repayments of federal premium subsidies provided to low-income and middle-class uninsured individuals in situations in which the subsidies turn out to be higher than the individuals were entitled.It is those provisions that the administration opposes.“This excise tax is one of several designed so that industries that gain from the coverage expansion will help offset the cost of that expansion,” the Office of Management and Budget said in a statement.“In sum, H.R. 436 would fund tax breaks for industry by raising taxes on middle-class and low-income families. Instead of working together to reduce health care costs, H.R. 436 chooses to refight old political battles over health care. If the president were presented with H.R. 436, his senior advisers would recommend that he veto the bill,” OBM said.

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Flexible Spending Accounts: Clarifying all the Recent Buzz and Legislation

Recently there has been quite a bit of buzz out of Washington regarding Flexible Spending Accounts (FSA). Two different things have recently taken place: 




#1 - The Internal Revenue Service on Wednesday provided regulatory relief for health care flexible spending account participants and also said it is reconsidering its longtime use-it-or-lose-it rule for FSAs.



Under that relief, the IRS said participants in noncalendar-year plans can still make the maximum contributions to their FSAs during the first year that a mandated FSA contribution cutback goes into effect under the health care reform law.


The issue involves a provision in the Patient Protection and Affordable Care Act, which goes into effect on Jan. 1, 2013. Under that provision, the maximum annual contribution employees can make to their FSAs will be $2,500. Under current law, there is no annual limit, though employers typically limit annual contributions to $4,000 to $5,000


To read a full article about this guidance click here

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# 2 The House Ways and Means Committtee voted on three separate changes to the FSA/HSA legislation that will be explained below. The key things to remember regarding these items is that they haven't yet been heard by the whole House, so they have not been voted into law as of this post.



Use-it-or-lose-it


A decades-old Internal Revenue Service rule that requires forfeiture of unused flexible spending account balances would be eased, and health care reform law-imposed restrictions on using FSAs and health savings accounts to pay for over-the-counter medications would be eliminated, under separate bills approved Thursday by a panel of the U.S. House of Representatives.


Under the Medical FSA Improvement Act of 2011, H.R. 1004, cleared by the House Ways and Means Committee on a 23-6 vote, employers could amend their FSAs to allow employees to withdraw as taxable cash up to $500 in unused balances remaining at the end of the plan year or at the end of an FSA grace period, if an employer has that feature.


The distribution would have to be made no later than seven months after the close of the plan year.
The committee action coincides with an IRS announcement this week that it will consider modifying the 1984 use-it-or-lose-it rule that requires forfeitures of unused FSA balances at the end of a plan year or grace period.


Over-the-counter medications


The other bill—the Restoring Access to Medication Act, H.R. 5842—which the committee approved on a 24-9 vote, would overturn an unpopular provision in the health care reform law that restricts the use of flexible spending accounts and health savings accounts to reimburse employees for OTC medications.
Under that provision, FSA reimbursement is permitted only if the employee obtains a prescription for the medication, while in the case of HSAs, OTC reimbursement is permitted without a prescription but a 20% federal tax is imposed on the distribution.


The bill approved by the House panel would eliminate those OTC restrictions in the health care reform law.

Retiree HSA distributions


A third bill, H.R. 5858, approved by a 21-7 margin, would allow retired employees who are at least age 55 but not yet eligible for Medicare to withdraw funds tax-free from their health savings accounts to pay premiums in early retiree health care plans offered by their former employers.


The three bills are expected to be considered by the full House next week.

Guidance Issued on 2011 FSA / HSA Changes

The Patient Protection and Affordable Care Act (PPACA) changed the requirements related to reimbursements for over-the-counter (OTC) drugs. These changes affect health FSAs, HRAs, HSAs and Archer MSAs, which will need a prescription to reimburse the costs of OTC drugs purchased after December 31, 2010.

On September 3, 2010, the IRS released IRS Notice 2010-59, which provides additional information on this requirement. The notice states:

· Reimbursement is restricted to prescribed drugs, insulin and OTC drugs that have a
prescription;

· Health FSA and HRA debit cards cannot be used for OTC drugs, except as provided in the notice; and

· Required cafeteria plan amendments must be adopted by June 30, 2011 and can be retroactively effective.

See www.ecfc.org/files/legislative-news/n-10-59.pdf for a copy of the Notice.

IRS NOTICE 2010-59

General Rule

The Notice provides guidance on Section 9003 of PPACA, which revises the definition of “medical expenses” for employer-provided accident and health plans, including health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs). PPACA Section 9003 also revises the definition of “qualified medical expenses” for health savings accounts (HSAs) and Archer medical savings accounts (Archer MSAs). Section 9003 applies after December 31, 2010.

Under these rules, tax-free payment or reimbursement is only available after December 31, 2010, for expenses incurred for a medicine or drug if the medicine or drug is a prescribed drug (determined without regard to whether the drug is available without a prescription) or is insulin. This means that these expenses may be paid or reimbursed by an employer-provided plan (including a health FSA or HRA) or reimbursed tax-free by an HSA or Archer MSA if the medicine or drug:

· Requires a prescription;
· Is an OTC medicine or drug and the individual obtains a prescription; OR
· Is insulin.

Note that expenses incurred for OTC medicines or drugs purchased without a prescription before January 1, 2011, may be reimbursed tax-free at any time, pursuant to the terms of the plan.

What Is a Prescription?

For purposes of these rules, the Notice clarifies that a prescription means a written or electronic order for a medicine or drug that meets the legal requirements of a prescription in the state in which the medical expense is incurred and that is issued by an individual who is legally authorized to issue a prescription in that state.

What About Other OTC Items?

The Notice makes clear that the requirement to get a prescription does not apply to OTC items that are not medicines or drugs, including equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits. These items can qualify for medical care if they otherwise meet the tax code’s definition of medical care, which includes expenses for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. However, expense for items that are merely beneficial to the general health of an individual, such as an expenditure for a vacation, are not expenses for medical care.

Rules for Debit Cards

In most cases, health FSA and HRA debit cards will not be able to be used to purchase OTC medicines or drugs, effective January 1, 2011. This is because current debit card systems are not capable of recognizing and substantiating that the OTC medicine or drug were prescribed. However, see below for an exception for purchases at certain pharmacies. Also, debit cards may continue to be used for medical expenses other than OTC medicines or drugs.

In order to facilitate the significant changes to existing systems necessary to reflect the new rules, the IRS will not challenge the use of debit cards for expenses incurred through January 15, 2011, as long as the use follows existing rules. However, on and after January 16, 2011, OTC medicine or drug purchases at all providers and merchants must be substantiated before reimbursement may be made. This is the case even if the provider or merchant has an inventory information approval system (IIAS). Substantiation is accomplished by submitting the prescription (or a copy of the prescription or other documentation that a prescription has been issued) for the OTC medicine or drug and other information from an independent third party that satisfies existing requirements.

The Notice gives examples of documentation that would satisfy the substantiation requirements for OTC medicines or drugs:

· A customer receipt issued by a pharmacy which identifies the name of the purchaser (or the name of the person for whom the prescription applies), the date and amount of the purchase and an Rx number.

· A similar receipt without an Rx number that is accompanied by a copy of the related prescription.

As noted above, there is an exception to the restrictions on debit card use for certain pharmacies. Prior IRS guidance (Notice 2007-2) provides that health FSA and HRA debit cards may be used at a pharmacy that does not have an IIAS if 90 percent of the store’s gross receipts during the prior taxable year consists of items which qualify as expenses for medical care under Internal Revenue Code Section 213(d). The Notice states that, until further guidance is issued, debit cards may be used at a pharmacy that satisfies the 90-percent test to purchase OTC medicines or drugs that have been prescribed, provided that substantiation is properly submitted in accordance with the terms of the plan. The prescription (or a copy of the prescription or other documentation that a prescription has been issued) and other information from an independent third party must be included. For the purpose of determining whether a pharmacy meets the 90-percent test, sales of OTC medicines and drugs at the pharmacy may continue to be taken into account after December 31, 2010.

Transition Rule for Cafeteria Plans

Cafeteria plans may need to be amended to follow the new requirements for OTC medicines and drugs. In general cafeteria plan amendments may be effective only prospectively. However, the Notice states that, notwithstanding the general rule against retroactive amendments, an amendment to conform to the cafeteria plan to the new OTC drug requirements that is adopted no later than June 30, 2011, may be made effective retroactively for expenses occurred after December 31, 2010 (or after January 15, 2011 for health FSA and HRA debit card purchases).

Effective Dates

For expenses incurred after December 31, 2010, payments or reimbursements for medicines or drugs from an employer-provided accident and health plan, including a health FSA or HRA, are restricted to prescribed drugs, insulin, and OTC drugs that are prescribed.

This effective date applies regardless of whether the plan year for the employer’s plan is a fiscal or calendar year or whether there is no plan year (or other coverage period in the case of an HRA), and regardless of any applicable grace period for a health FSA.
Tax-free distributions for qualified medical expenses from an HSA or Archer MSA for medicines or drugs purchased after December 31, 2010, are restricted to prescribed drugs, insulin and OTC medicines or drugs that are prescribed.