Reading Room

Not What the Doctor Ordered:
IRS Allows Nonprescription Drugs to Be Run through Flexible Spending Plans

by Jeff Storch
Boardman Law Firm

In a reversal of its previous position, the IRS recently ruled that health flexible spending arrangements (health FSAs) may reimburse participants for nonprescription medicine and drugs.

In its ruling, the IRS found that expenses for nonprescription antacid, allergy medicine, pain reliever and cold medicine could be reimbursed under a health FSA as medical care, although such expenses would not be deductible as itemized medical expenses. (Under the medical expense itemization rules, medicine and drugs generally only can be deducted if obtained by prescription.)

Previously, the IRS had taken the position that because nonprescription medicine or drugs were not deductible as itemized medical expenses, health FSAs similarly could not reimburse for them. In changing its position, the IRS explained that, while the health FSA rules incorporate the definition of medicine and drugs used in the itemization rules, the health FSA rules do not incorporate the prescription requirement.

The IRS characterized the ruling as a clarification and simplification, rather than a change in existing law. Therefore, health FSAs that broadly allow reimbursement of "medical care" may not need to be amended to permit reimbursement of nonprescription drugs and could begin reimbursing such expenses immediately. Some plans, however, specifically prohibit reimbursement of nonprescription drugs. These will need to be amended before permitting participants to take advantage of the new rules.

Alternatively, employers may not wish to allow reimbursement of nonprescription drugs. (The ruling does not require health FSAs to reimburse such expenses.) For example, an employer might be concerned about what substantiation is required and prefer not to spend the administrative resources on it. These employers should amend their plans to specifically exclude nonprescription drugs.

This ruling may encourage some employers to adopt health FSAs for the first time and is welcome to the many employers who wish to design their health FSAs and cafeteria plans to maximize employer and employee tax savings. But regardless of how health FSA sponsors decide to treat nonprescription drugs, their plan documents, summary plan descriptions, election forms and other plan materials should be examined and revised as necessary.

If you have any questions on the new ruling or health FSAs and cafeteria plans in general, please contact Jeff Storch at (608) 283-1781 or jstorch@boardmanlawfirm.com.

October 2003