United States: OTC Drugs May Be Purchased Through Flex Plans

The IRS recently ruled that expenses for over-the-counter drugs may be paid from health flexible spending arrangements (commonly known as "health FSAs"). This was announced in Revenue Ruling 2003-102, which was issued September 3, 2003.

The ruling clarifies that health FSAs may pay for legally obtained medicines and drugs, regardless of whether they are prescribed by a doctor. However, the ruling points out that health FSAs may not reimburse participants for acquiring dietary supplements, such as vitamins, that are merely beneficial to good health generally, or for the cost of toiletries, cosmetics and sundry items.

What is a health FSA? A health FSA is a type of health plan that employers may provide for their employees. Under a health FSA, amounts deducted from an employee’s pre-tax pay are used to reimburse expenses for medical care that is not covered by other group medical or insurance plans. Often health FSAs are offered as part of a "cafeteria plan" or "flexible spending plan."

Will health FSAs need to be amended to take advantage of this ruling? Many health FSAs will have to be amended before paying for OTC medicines and drugs. This is because health FSA plan documents often provide that, in order to be reimbursable, expenses must be deductible under Code section 213 (disregarding the limitation of section 213(a)). A plan containing such a provision would have to be amended before permitting payment for OTC medicines and drugs, because those items are not deductible under Code section 213.

In its recent ruling, the IRS clarified that in order to be reimbursed under a health FSA, an expense must meet the definition of "medical care" under Code section 213(d), but does not have to be deductible under Code section 213. Therefore, plans containing the "deductibility" requirement must be amended before taking advantage of the more lenient rule.

What expenses can be reimbursed under a health FSA? Generally, any expense that is for "medical care" (as defined in Code section 213(d)) can be reimbursed under a health FSA.

Code section 213(d) provides that the term "medical care" means "amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body." Generally, any expense meeting that definition may be paid under a health FSA. However, there are a few exceptions.

The following may not be paid from a health FSA:

• Premiums paid for other health coverage (such as a group medical plan or health insurance plan);

• Expenses that are reimbursable under any other medical insurance benefit plan or policy, or otherwise recoverable from any source.

The IRS’s recent ruling also made clear that items that are merely beneficial to general good health are not reimbursable under health FSAs. The ruling states that purchases of toiletries such as toothpaste and cosmetics, and dietary supplements such as vitamins, are not expenses for "medical care" and are therefore not reimbursable under a health FSA.

Finally, according to the IRS, the following items are for "medical care" and are therefore reimbursable under health FSAs: antacids, allergy medicines and pain relievers, whether or not prescribed by a doctor.

Can health FSAs pay for OTC drugs purchased prior to the plan’s amendment date? Generally, the answer will be "yes." Most health FSAs provide for reimbursement of eligible expenses that were incurred at any time during the plan year. A health FSA containing this provision can pay for OTC drugs that were purchased as early as the first day of the current plan year, once the plan has been amended as described above (or once it is determined that it needs no amendment).

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