We all know that health
Earlier this year, the IRS issued an alert warning administrators of FSA, HRA and HSA plans and participants in those savings vehicles that some companies are misrepresenting the circumstances under which food and
Understanding the long-standing rules about which medical expenses are qualified to be reimbursed by the account-based health plan is an important factor in administering these plans in a manner that ensures the tax benefits of the plans are retained. People asking for reimbursements from these plans, and therefore, administrators need to be aware of the rules and regulations.
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While the practice of medicine continues to evolve, the underlying provisions of the Internal Revenue Code have not changed. Perhaps, it is time for Congress to review and revise its rules regarding qualifying medical expenses. However, until the IRC is amended, the current rules must be followed.
The IRC allows an itemized deduction for medical expenses that exceed 7.5% of adjusted gross income. IRC Section 213(d)(1) defines "medical care" as amounts paid for "the diagnosis, cure, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body." Expenses that are merely beneficial to general health, such as vitamins or a vacation are not considered expenses for medical care.
The IRS sets out its interpretation of expenses for medical care in Publication 502, Medical and Dental Expenses. The conclusions it outlined are based on previously published regulations and rulings issued by the IRS appearing in a format that the general public can understand. As either a plan participant or administrator, Publication 502 should be the first stop in determining whether an expense is for medical care.
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The definition of medical care is relevant for account-based health plans, since their favorable tax treatment is dependent on whether distributions from these plans are for medical care as defined in IRC Section 213(d)(1). Distributions from an FSA or an HRA must only be for qualified medical expenses, and plan administrators must substantiate that fact before making a distribution from the plan. Distributions from an HSA will be taxable to the HSA owner unless the distribution is to reimburse an expense for medical care. It is up to the HSA owner to provide that the reimbursement is for a medical expense.
The tax consequences of failing to follow the rules established for these plans can be quite severe. On April 28, 2023, the IRS released an Office of the Chief Counsel memorandum that detailed the claims substantiation requirements provided under IRS proposed regulations for reimbursement of medical expenses from a health FSA.
The memorandum also detailed the tax consequences of a health FSA not following the claims substantiation requirements. It focused on instances where payment of claims from a health FSA did not follow the substantiation rules set out in the regulations. If a health FSA does not follow the claims substantiation rules set out in the regulations, the memorandum states that the entire health FSA does not comply with IRC and employee salary reduction contributions to these noncompliant plans will be subject to income, FICA and FUTA taxes.
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That means claims paid from the plan that were not properly substantiated will be taxed. Another consequence is that all employee salary deferral elections to the non-compliant plan will be subject to a major tax penalty to all employees who make what they thought were pretax contributions to a health FSA.
Similarly, the IRS issued an alert on March 6, 2024, warning administrators of FSA, HRA and HSA plans and participants that some companies are misrepresenting the circumstances under which food and wellness expenses can be paid or reimbursed under these plans. The IRS noted that just because a company provided a letter of medical necessity from a doctor based on self-reported health information, it does not necessarily mean that otherwise personal expenses would be considered a qualified medical expense that could be reimbursed by an FSA, HRA or HSA.
An example under the alert would be a person who is a diabetic and wants to control his or her blood sugar by eating heathier. Let's say that individual views an advertisement for a company that suggests submitting receipts for heathy foods, along with a doctor's note it will provide, to the health FSA administrator to be reimbursed for those expenses. The problem with that scenario is the IRS states the doctor's note does not convert a personal expense to a qualified medical expense that can be reimbursed from an FSA, HRA or HSA.
It should be noted that on March 17, 2023, the IRS released frequently asked questions (FAQs) about when medical expenses related to nutrition, wellness and general health would be considered a medical expense that could be reimbursed from an FSA, HRA or HSA. If the expense on one of those expenses is outlined in the FAQs, then it would be appropriate to seek reimbursement by the plan. Unfortunately, in the situation outlined in the alert, the expenses covered by the doctor's note went well beyond what was outlined in the FAQs.
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Account-based health plans are an important way for people to finance their health care expenses. For employers that are interested in setting up one of these plans, it is important that the plan administrator follow the rules set up for these plans so that the promised tax benefits can be delivered. The plan administrator also should be aware of companies that use technology that does not follow the medical expense rules established under the IRC.
While there are good reasons to encourage healthy lifestyle habits, the IRS on its own cannot change rules set out in the IRC. Congress would need to change the current law to expand what is a proper expense for medical care. It's not unheard of for Congress to amend the rules to allow more expenses to be covered by FSAs, HRAs and HSAs.
As part of the changes to the IRC made at the height of the COVID-19 pandemic, Congress amended the IRC in the CARES Act to allow expenses for feminine hygiene products paid after December 31, 2019 to be reimbursed by FSAs, HRAs and HSAs. Rather than fault the IRS for not taking an expansive view of what expenses that promote a healthy lifestyle, advocates of tax breaks for a healthy lifestyle should ask Congress to amend the current rules. In the meantime, there's no escaping those rules.
