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Employer Health Reform Issues Brief: Health Savings Account Reimbursements

Smart first steps


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The provision

Distributions from Health Savings Accounts (HSAs) to pay for a medicine or drug will not be qualified medical expenses unless the medicine or drug:

  • can be obtained only with a prescription
  • is available without a prescription (i.e., “over-the-counter”) but the individual obtains it with a prescription, or
  • is insulin.

Any distributions from an HSA for nonqualified medical expenses are includable in the HSA beneficiary’s gross income and subject to a 20% excise tax. However, the excise tax does not apply if the HSA beneficiary is at least 65 years old.

The requirement to have a prescription will apply only to medicines and drugs. As a result, medical equipment (e.g., crutches), supplies (e.g., bandages) or diagnostic tests (e.g., blood sugar test kits) can still be qualified medical expenses even if purchased without a prescription.

Effective date: Medicines or drugs purchased after December 31, 2010. HSA reimbursements for over-the-counter medicines or drugs purchased on or before December 31, 2010 generally will not be includable in gross income or subject to the 20% excise tax even if the actual HSA distribution occurs on or after January 1, 2011.

Example

Employee purchases over-the-counter drugs on December 31, 2010, but does not submit a claim for reimbursement to her HSA trustee until January 15, 2011. The HSA distributes the reimbursement to Employee on January 31, 2011. Assuming the over-the-counter drugs otherwise meet the requirements for qualified medical expenses, the distribution will not be includable in Employee’s gross income or subject to the 20% excise tax because the over-the-counter drugs were purchased before January 1, 2011

Key implication: Plan design

The inability to receive tax-free reimbursements from HSAs for over-the-counter medicines and drugs may affect the economics of consumer-driven health plan (CDHP) designs for participants. In order to avoid adverse tax consequences, either a prescription will be required or these expenses will have to be paid out-of-pocket, with after-tax money. This could make the CDHP less appealing to participants who are accustomed to using their HSAs to purchase over-the-counter medicines.

What is a “qualified medical expense”?

Under the Internal Revenue Code, a “qualified medical expense” generally means any expense incurred for the diagnosis, cure, mitigation, or treatment of disease, or for the purpose of affecting any structure or function of the body. Examples include payments for medical services, equipment, supplies and diagnostic devices. Items that are merely beneficial to the individual’s general health or wellbeing, such as a vacation, are not medical care.

Insurance premiums generally are not “qualified medical expenses,” subject to specific exceptions for COBRA premiums and qualified long-term care insurance premiums, among others.

What is a “prescription”?

The new rules define a “prescription” as a written or electronic order for a medicine or drug that meets the legal requirements of a prescription in the state in which the medical expense is incurred, issued by someone legally authorized to issue prescriptions in that state.

Smart first steps for employers to consider

Plan design: Identify and assess possible modifications to CDHP designs to address potential employee concerns about the new tax treatment of distributions for over-the-counter medicines and drugs. For example, slightly increasing employer contributions to employees’ HSAs could help offset any negative reaction to this rule change.

Communications: Develop and implement a communications strategy to educate employees about the new rules and remind them of the tax consequences of using their HSAs to pay for nonqualified medical expenses.

As used in this document, “Deloitte” means Deloitte Consulting LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.

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