In Notice 2010-59, the Internal Revenue Service (the “IRS”) provides guidance on the treatment of over-the-counter-drugs under Section 9003 of the Patient Protection and Affordable Care Act (the “Affordable Care Act”), enacted March 23, 2010. Section 9003, and the rules described below, generally apply for medicines and drugs purchased after 2010.
According to the Notice, Section 106 of the Internal Revenue Code (the “Code”) provides that the gross income of an employee does not include employer-provided coverage under an accident or health plan. Section 105(b) of the Code generally provides that the gross income of an employee does not include amounts paid as reimbursements for medical care under an employer- provided accident or health plan. Section 106(f) was added to the Code by Section 9003 of the Affordable Care Act. Under Section 106(f), for purposes of Sections106 and 105 of the Code, expenses incurred by an employee for medicines or drugs may be paid or reimbursed tax-free by an employer-provided plan, only if the medicine or drug (1) requires a prescription, (2) is available without a prescription (an over-the-counter medicine or drug) and the individual obtains a prescription, or (3) is insulin. The foregoing applies to payments or reimbursements made by a health flexible spending account (an “FSA”) or an employer-sponsored health reimbursement arrangement (an “HRA”).
The Notice further says that Section 9003 of the Affordable Care Act also amends Section 223(d)(2)(A) of the Code, with respect to health savings accounts “(HSAs”). Under revised Section 223(d)(2)(A), a distribution from an HSA for a medicine or drug is a tax-free qualified medical expense only if the medicine or drug meets (1), (2) or (3) above. If amounts are distributed from an HSA for any medicine or drug which does not satisfy one of these requirements, the amounts will be treated as a distribution for nonqualified medical expenses, and will therefore be includable in gross income and generally subject to a 20% additional tax. The new rules do not affect HSA distributions for medicines or drugs made before 2011, or distributions made after 2010 for medicines or drugs purchased before 2011.
For these purposes, a “prescription ” is a written or electronic order for a medicine or drug that meets the legal requirements of a prescription in the state in which the medicine or drug is purchased, and which is issued by an individual who is legally authorized to issue a prescription in that state. The foregoing rules do not apply to items that are not medicines or drugs, such as equipment (e.g., crutches), supplies (e.g., bandages), and diagnostic devices (e.g., blood sugar test kits). Such items may qualify as medical care if the requirements of Section 213(d)(1) of the Code are met. The Notice contains some special rules for using FSA and HRA debit cards to purchase over-the-counter medicines and drugs. Cafeteria plans may need to be amended to conform to the new over-the-counter drug requirements. Pursuant to Prop. Treas. Reg. § 1.125-1(c), cafeteria plan amendments may be effective only prospectively. However, under the Notice, an amendment to conform a cafeteria plan to the requirements included in the Notice, which is adopted no later than June 30, 2011, may be made effective retroactively for medicine or drug purchases made after 2010.