In Revenue Ruling 2003-102, the IRS clarifies that insured and self-insured health plans, including health flexible spending accounts (FSAs), health reimbursement arrangements (HRAs) and consumer-driven health plans (CDHPs), may allow participants to pay for over-the-counter (OTC) drugs with pretax dollars. This is a departure from the agency’s previously stated position that OTC medications should not be reimbursable under medical plans. While all employer health plans could be affected by this ruling, the most likely candidates for amendment are health FSAs.
What May Be Reimbursed?
This ruling opens the door to OTC medications, but not to cosmetic remedies, vitamins, dietary supplements or similar non-medical items. However, the ruling does not explicitly define an OTC medicine or drug, and the distinction is not exactly clear. The law tells us that a medicine or drug must be for the “diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body.” Under IRS regulations, a medicine or drug must be legally procured, generally accepted as a medicine or drug, and not a toiletry or cosmetic, such as toothpaste, shaving lotion, face cream, deodorant or hand lotion. From the IRS revenue ruling itself, we know that antacids, allergy medicines, pain relievers and cold medicines are all acceptable medicines or drugs, but vitamins and dietary supplements used for general health and well-being are not. Nevertheless, there is a wealth of other “remedies” that can be used to alleviate or treat sickness. For example, how should a plan classify calcium chews, calamine lotion, acne remedies, dandruff shampoo, OTC contraceptives and freezer gel packs? What about when a physician recommends or “prescribes” a vitamin or supplement to alleviate or mitigate a specific disease or condition? Plan administrators and employers will have to grapple with these issues, without much guidance to help them.
A Matter of Employer Choice
The new ruling does not require or mandate plans to cover or reimburse any or all OTC drugs. Some employers may decide to leave their plans alone for the next year, until the details of implementation become clearer. Other employers may amend their plans to cover only certain OTC drugs, such as drugs that have recently become OTC in lesser concentrations. An employer’s course of action may depend on the employer’s experience with unused funds or employee participation in the health FSA. Employers trying to increase employee participation or provide a benefit enhancement — in today’s climate of benefit reductions — may be particularly interested in taking advantage of the new ruling.
Plan Documents and Substantiation Requirements
Most employers that decide to allow OTC reimbursements will need to amend plan documents, including summary plan descriptions (SPDs) and other employee communications detailing reimbursement policies. Some plan documents currently allow participants to seek reimbursement for any expense the IRS allows, in which case an amendment may not be necessary in order to cover OTC medical expenses. Generally, plans may only reimburse OTC medical expenses incurred after the new ruling. Even if the plan is modified mid-year to expand coverage, that modification would not trigger a new election period for employees, according to the IRS. The simplest approach for many employers may be to amend documentation and implement a provision allowing for the reimbursement of OTC medical expenses for the 2004 plan year.
Employer plans must require adequate substantiation before reimbursing OTC drug expenses, and the implementation could be somewhat burdensome. Each expense must be substantiated with a receipt specifying the drug name and the purchase date and matched against the claim, with the participant’s certification that he or she incurred the expense, that it has not been reimbursed and that it will not be submitted for reimbursement from any other source. Participating plans will receive receipts from all types of stores where OTC medications are sold, such as pharmacies, grocery, retail and convenience stores, and gas stations. For plans using debit cards, after-the-fact adjudication will be necessary because most plans will not have merchant codes for all establishments that sell OTC drugs.
Employers need to decide if and when to cover OTC drugs and in which plans. They also will need to determine which drugs to cover, whether their FSA vendors can administer the reimbursement of OTC drugs and whether they will impose additional charges for processing these new claims. And regardless of their decisions, employers should communicate their position to employees, since the IRS ruling has received considerable media attention.