IRS Revenue Ruling 2003–43 provides guidance to plan sponsors that offer participants in Health Flexible Spending Accounts (“Health FSAs”) and Health Reimbursement Arrangements (“HRAs”) the ability to use electronic payment cards to pay service providers at the point of sale. The electronic card may be a debit card or a credit card. However, the following requirements must be met in order for Health FSAs or HRAs offering these cards to maintain the tax benefits associated with these plans.
Upon enrollment, and each plan year thereafter, participants must certify that they will only use the card for eligible medical expenses (as defined in the Health FSA or HRA) for themselves and their spouse and dependents. In addition, participants must agree that any expenses paid with the card have not been reimbursed and that reimbursement will not be sought under any other plan. This certification is reaffirmed with each use of the card; the certification must be written on the back of the card as well as on the enrollment form. In addition, participants must agree to acquire and maintain sufficient documents to substantiate the expenses that have been paid with the card.
The card must be limited to the amount of coverage elected by the participant under the Health FSA or HRA. Cards can only be effective at certain merchants or service providers for specified merchant category codes. IRS Ruling 2003–43 states that the use of the card must automatically be cancelled at termination of employment. Although the IRS has informally stated that COBRA beneficiaries may use the card, it recommended against this use, because of the inability to administer the required correction procedures (see below).
All claims must be substantiated, automatically or manually, and there must be meaningful procedures in place to recover improper payments.
There are three categories of transactions where substantiation is automatic:
- If the card transaction exactly matches the dollar amount of a co-payment under the participant’s other health plans, the charge will be considered substantiated. For example, a transaction that exactly matched the dollar amount for a co-payment under the participant’s major medical plan for the services received would be considered automatically substantiated.
- If the expense matches an expense previously approved as to amount, provider and time period, the charge will be considered substantiated. For example, a previously approved prescription that is regularly refilled by the same pharmacist for the same amount would be considered automatically substantiated.
- If there is real-time adjudication of the expense from an independent third party (i.e., the merchant or service provider verifies that it is a charge for qualifying medical expenses) then the charge will be considered substantiated.
If the transaction cannot be automatically substantiated as described above, it must be manually substantiated. The transaction is treated as conditional pending confirmation of the charge. After the transaction, the participant must submit additional third party information to the claims administrator for the Health FSA or HRA. The third party substantiation must:
- describe the service or product;
- contain the date of service or sale; and
- state the amount of the expense.
IRS Revenue Ruling 2003–43 specifically rejects a system that employs sampling techniques (i.e., where the plan sponsor only reviews a certain percentage of the transactions).
The plan sponsor must adopt correction procedures for any ineligible expenses that are paid by the participant by means of the card. The correction procedures could be:
- requiring repayment of the amount of the improper claim;
- withholding the amount of improper payments from the employee’s wages (so long as this correction procedure met the requirements of applicable state law); or
- offsetting an improper claim with one or more substantiated claims in the same coverage period, thereby denying further reimbursements until the improper claim is reimbursed.
As a last resort, the IRS has informally stated that it would be permissible to add the improper payment to the participant’s Form W-2.
Plan Amendments Required
The substantiation procedures and the correction procedures must be set forth in the Health FSA or HRA plan document. Plan amendments must be adopted prior to the period of coverage for which the electronic card will be effective.
IRS Revenue Ruling 2003–43 did not address the ability of the plan to charge participants for the card fees. However, the IRS has informally stated that fees could be charged against the participant’s Health FSA or HRA account if the participant is advised in writing, prior to enrolling for the card, both about how the fees will be taken from the participant’s account and how the fees are calculated.
IRS Form 1099–MISC Is No Longer Required
IRS Revenue Ruling 2003–43 required that the plan sponsor issue a Form 1099–MISC to a provider that is paid using the card, if a Form1099–MISC would be required by Internal Revenue Code section 6041. Internal Revenue Code section 6041 requires that all persons who make payment in the course of their business to another person of $600 or more in a taxable year are required to file a Form 1099–MISC. The recent Medicare legislation that was signed by the President provides, among other things, an exception to the Form 1099 reporting requirements for Health FSAs and HRAs. Accordingly, a Form 1099–MISC is no longer required in this situation.