January 14, 2011
Health Care Reform Update
Over-the-Counter Rules Affect Use of Health FSA and
HRA Debit Cards
The Patient Protection and Affordable Care Act changed the treatment of over-the-counter (OTC)
medicines formerly reimbursable through health flexible spending accounts (health FSAs), health
reimbursement arrangements (HRAs) and health savings accounts (HSAs). Specifically, OTC medicines
and drugs are no longer eligible for reimbursement through these tax-favored accounts. Under the new
rules, a medicine or drug is a reimbursable medical expense only if it:
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Is a prescribed drug;
Is an OTC drug and the individual obtains a prescription; or
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Is insulin.
These new restrictions on OTC medicines and drugs have added a wrinkle to the use of health FSA and
HRA debit cards, because a prescription for the OTC medication must be substantiated before a
reimbursement is allowed through these tax-favored accounts. Current debit card systems are not
capable of substantiating compliance with the new rules regarding OTC medicines, therefore. the IRS has
issued two notices giving us guidance on whether and when a debit card may be used for OTC medication
at the point of sale.
The IRS has indicated that it will not challenge the use of debit cards for expenses incurred through
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January 15, 2011 if the store is a "90% pharmacy” and the prescription is properly substantiated or if the
merchant has an inventory information approval system (IIAS) to substantiate that the item is an
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appropriate medical expense as defined by Internal Revenue Code § 213. Notice 2010-59 also indicated
that debit card use for OTC medications, even if prescribed, would be barred following January 15, 2011.
Additional guidance was issued and reversed the IRS’s initial position, allowing the continued use of debit
cards at certain vendors that meet specific requirements. Therefore, beginning January 16, 2011, debit
cards accessing a health FSA or HRA may be used to purchase OTC medicines at drug stores, pharmacies,
non-health care merchants that have pharmacies and mail-order and web-based vendors, provided the
following requirements are met:
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
Prior to purchase:
o The prescription is presented to the pharmacist;
o The OTC medicine is dispensed by the pharmacist according to the laws pertaining to the
practice of pharmacy; and
o An Rx number is assigned;
The pharmacy (or other vendor) retains a record of the Rx number, the name of the purchaser
and the date and amount of the purchase in a manner meeting IRS recordkeeping requirements;
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Notice 2010-59.
A store 90% of whose gross receipts consist of items qualifying as expenses for medical care under § 213.
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Notice 2010-59. See also Treas. Prop. Reg. § 125-6, Rev. Rul. 2003-43, Notice 2006-69, Notice 2007-2, and Notice
2008-104.
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These records are available to the employer upon request;
The debit card system will not accept a charge unless an Rx number is assigned; and
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Merchants follow IRS rules on debit cards in place prior to health reform.
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Also, health FSA and HRA debit cards may be used at merchants having health care related Merchant
Codes provided the following rules are met:
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

The pharmacy (or other vendor) retains a record of the name of the purchaser and the date and
amount of the purchase in a manner meeting IRS recordkeeping requirements;
These records are available to the employer upon request; and
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Merchants follow IRS rules on debit cards in place prior to health reform.
Finally, health FSA and HRA debit cards may be used at a pharmacy that does not have an IIAS if 90
percent of the store’s gross receipts during the prior taxable year consists of items which qualify as
expenses for medical care under Code § 213(d). Until further guidance is issued, debit cards may be used
at a pharmacy that satisfies the 90-percent test to purchase OTC medicines or drugs that have been
prescribed, provided that substantiation is properly submitted, in accordance with the terms of the plan,
including the prescription (or a copy of the prescription or other documentation that a prescription has
been issued) and other information from an independent third party that satisfies the substantiation
requirements.
For all other providers and merchants, other than those described above, health FSA and HRA debit cards
may not be used to purchase OTC medicines or drugs after January 15, 2011.
The above point-of-sale substantiation requirements do not apply to debit cards attached to HSAs.
However, any reimbursement from an HSA, whether or not through an associated debit card, that is not
for a medical expense as defined by Code § 213 is considered taxable income and subject to a 20% excise
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tax. An individual using an HSA for reimbursement of a prescribed OTC medication should retain the
prescription in case it is needed in the event of an audit.
Employers should review their cafeteria plan document to make sure that it is up to date with the rules
regarding reimbursement of medical expenses by June 30, 2011. In addition, communication around the
use of debit cards for health FSAs, HRAs and/or HSAs may be necessary.
These materials are produced by Kibble & Prentice/USI Insurance Services for educational purposes only. Certain information contained in these
materials is considered proprietary information created by Kibble & Prentice/USI. Such information shall not be used in any way, directly or indirectly,
detrimental to Kibble & Prentice/USI and/or their affiliates. Neither Kibble & Prentice/USI nor any of its respective representatives or advisors has made
or makes any representation or warranty, expressed or implied, as to the accuracy or completeness of these materials. Neither Kibble & Prentice/USI
nor their respective representatives or advisors shall have any liability resulting from the use of these Materials or any errors or omission therein. These
materials provide general information for the use of our clients, potential clients, or that of our clients’ legal and tax advisors.
IRS Circular 230 Disclosure: USI Insurance Services and its affiliates listed below do not provide tax advice. Accordingly, any discussion of U.S. tax
matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion,
marketing or recommendation by anyone unaffiliated with USI Insurance Services of any of the matters addressed herein or for the purpose of avoiding
U.S. tax-related penalties. Also, the information contained in this brochure should not be construed as medical or legal advice and is intended for
educational purposes only.
USI affiliates: Kibble & Prentice Holding Company dba Kibble & Prentice operates in the State of California under the name of Kibble & Prentice
Holding Company dba Kibble & Prentice Insurance Agency (0E28835). Campbell, Galt & Newlands, Inc. dba USI Northwest operates in the State of
California under the name of Campbell, Galt & Newlands, Inc. dba USI Northwest Insurance Agency (0734627). USI Insurance Services of Northern
California, Inc. operates in the State of California under the name of USI Northern California Insurance Services (0B84501)
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Notice 2011-5.
Other than drug stores, pharmacies, non-health care merchants that have pharmacies and mail-order and webbased vendors.
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Notice 2011-5. See also Footnote 3.
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The PPACA increased the penalty tax from 10% to 20% beginning January 1, 2011.
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Kibble & Prentice offers securities through M Holdings Securities, Inc., a registered broker/dealer, member FINRA/SIPC. Kibble & Prentice, a
registered investment adviser, offers investment advisory services. Kibble & Prentice is independently owned and operated.
Please contact us if you have any questions regarding the content of this document.
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