On July 11, 2006, the Internal Revenue Service (IRS) issued new guidance on the use of debit cards, credit cards, and stored value cards (electronic payment cards) for Flexible Spending Accounts (FSA), Health Reimbursement Accounts (HRA), and dependent care assistance programs (DCAPs). Expanding upon the original electronic card guidance issued in Rev. Rul. 2003-43), the new guidance adds new methods for substantiating claimed medical expenses, whether or not a card is used. Additionally, for the first time, the ruling provides guidance on the use of cards to reimburse participants in dependent care assistance programs.

Applicability

As many employers begin to adopt a debit card approach to the administration of flex plans and HRAs, it is important to know what the IRS will accept as proof that the claim has been substantiated. If the claim is not substantiated property, the flex plan or HRA may be disqualified, resulting in income tax, social security withholding, and other tax penalties to the employer based on the fact that the benefits under the plan are now taxable.

As under the earlier ruling, the IRS affirms that statistical sampling is not an acceptable method for substantiation. Every claim must be substantiated.

Discussion

Rev. Rul. 2003-43, issued in May, 2003, validated the use of employer provided debit or credit cards in connection with flexible spending accounts, but made it clear that to be eligible, each claim must be substantiated.  The IRS will presume that the substantiation is complete if all of the following criteria are met:

1.       Employee Certification. Participants certify upon enrollment, and reaffirm each new plan year, that the card will only be used for eligible medical care expense of the employee, spouse and dependents.  In addition, participants must certify that any expense paid with the card has not been reimbursed and that the employee would not seek reimbursement under any other plan covering health benefits. The IRS requires that this certification must appear on the back of the card and that the cardholder agrees that the certification is reaffirmed each time the card is used.

2.       Limitation on Amount. The aggregate amount of expenses that may be paid with debit or credit card must be limited to the maximum dollar amount of coverage elected under the employee’s health FSA or HRA.

3.       Authorized Merchants and Service Providers. Reimbursements for medical expenses may only be processed if they are used at certain merchants and service providers that have merchant category codes (MCC) related to health care. 

Original Three Methods

The 2003 guidance offered three methods of automatic substantiation:

1.       Co-payment match

2.       Recurring expense

3.       Realtime substantiation (e.g., exchange of information at point of service)

All other card charges were to be treated as conditional, pending confirmation and substantiation by submission of additional information (e.g., receipts sent to TPA). Claims that are identified as not qualifying for reimbursement due to lack of information or otherwise are subject to certain correction procedures.  The plan document must include meaningful correction procedures for claims that are subsequently identified as permissible, including requiring the employee to repay the amount.  Moreover, cards systems that do not meet the requirements of § 105(b) result in all payments provided by the cards being included in the participant’s income.

Additional Methods of Substantiation

In addition to substantiation methods approved in Rev. Rul. 2003-43, an employer may adopt additional methods for substantiating claimed expenses as provided in Notice 2006-69.  These methods include, but are not limited to, employee certifications and adoption of meaningful correction procedures for amounts that are not automatically substantiated at the point-of-sale or within a reasonable time after the transaction.  The following circumstances allow employers to accept payment by electronic means without the need for further substantiation or review:

1.       Co-Payment Amounts. The new guidance allows automatic substantiation for certain card transactions involving multiple co-payments at merchants or service providers with health-care related MCCs.  To qualify, the dollar amount of the transaction must equal an exact multiple of the co-payment for the specific service (i.e., pharmacy benefit co-payment, office visit co-payment, etc.) under an accident or health plan of the employer covering the specific employee cardholder, up to a maximum of five times the co-payment amount. If the five times limit is exceeded, the card can still be used, but the employee must later submit paperwork, such as a receipt for services substantiated by the merchant or service provider (independent third-party). If the dollar amounts of the transaction are not an exact multiple of the co-payment, the amount must be treated as conditional pending confirmation of the charge, even if the amount is less than five times the co-payment.

2.       Inventory Information Approval System. This method will allow automatic substantiation of OTC drugs and similar items purchased with automatic substantiation even at merchants without health-care-related MCCs, so long as inventory information approval systems are in place to ensure that cards are used only for eligible medical care expenses. The guidance requires a system that uses inventory control information (e.g., stock keeping units (SKUs)) to compare the items purchased against a list of items that qualify as medical care expenses under Code Section 213(d). The system approves the use of the card only for eligible medical care expenses; and when a transaction is not approved in full, the employee must tender additional amounts. Most importantly, employers whose health FSA or HRA cards are programmed to work with such a system must be able to produce auditable records of all transactions.

3.       Other Substantiation Issues:

a.       EOBs. If an employer receives an explanation of benefits (EOB) or similar information from an insurer or other independent third party indicating the date of a Code Section 213(d) medical care expense and the employee's responsibility to pay for the expense (i.e., as co-insurance or to satisfy a deductible), the claim is fully substantiated. 

b.       Prohibition against Self-certification. The guidance expressly provides that expenses cannot be reimbursed based on an employee's self-substantiation (including via internet, intranet, facsimile or other electronic means). For example, a plan may not reimburse expenses based solely on a participant's e-mail describing the type of expense, the amount, and the date; without appropriate third-party substantiation.  Under § 1.105-2 of the regulations, all amounts paid under a plan that permits “self-substantiation” or “self certification” will cause all amounts, whether or not substantiated, to be included in gross income.

4.       DCAPs. The guidance indicates a way to use electronic payment card programs for DCAPs. However, dependent care expenses may not be reimbursed before the expenses are incurred.  Therefore, expenses are incurred when the dependent care services are provided (e.g., if paying monthly, the expense isn't considered incurred until the last day of the month in which the care was provided).

The IRS will permit auto-adjudication of monthly DCAP expenses so long as the employee pays the initial expense and submits a written statement from the provider substantiating the due dates and amounts payable during the plan year. If the expense is for services already incurred and if necessary balance is in the DCAP account, then the plan can pay the provider through the card. The amount available through the card can only be increased after the employee has incurred the additional expenses.

The text of Notice 2006-69 is available online at http://www.irs.gov/pub/irs-drop/n-06-69.pdf

 

Effective Dates

The requirements of the IIAS recordkeeping system became effective for plan years beginning after December 31, 2006. All other provisions are currently effective.

Conclusion

Plan sponsors and administrators should undertake a careful review of their current systems now, as many common industry practices may be adversely affected by this new guidance. 

With respect to the Inventory Information Approval System, an employer that uses this system complies with the recordkeeping requirements of this notice (including Rev. Proc. 98-25) is effective for plan years beginning after December 31, 2006.  The information required to be retained may be provided at the time of the transaction, or after the transaction (e.g., upon an examination of the employer by Internal Revenue Service).  Rev. Proc. 98-25, sets out requirements where a taxpayer’s records that are maintained within an automatic data processing system, also applies to the inventory information approval system. 

 

 

 

Copyright © 2006 Alfred B. Fowler, Attorney at Law.
All Rights Reserved. Reprint with permission only.
This legislative update is published as an information source for our clients and colleagues. It is general in its nature and is no substitute for legal advice or an opinion in a particular case.

 

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