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Overview of Changes

The IRS has issued guidance regarding the use of debit cards provided with Flexible Spending Accounts (FSAs) and Health Reimbursement Accounts (HRAs).  The rules impact how these debit cards may be used at non-healthcare related merchants.  

By the end of 2007, all grocery stores, discount stores, warehouse stores and online pharmacies that accept FSA and HRA debit cards must have implemented an Inventory Information Approval System (IIAS).  An IIAS is a computer system that recognizes whether an expense is eligible or ineligible for FSA/HRA reimbursement under IRS guidelines.  Grocery stores, discount stores and warehouse stores– even those that dispense prescription medications– typically do not have a health care merchant category code and sell many items which do not qualify as medical expenses as determined by the IRS.  Because of the potential for misuse of FSA and HRA debit cards, the IRS has stated that they can no longer be used at stores that have not adopted an IIAS.

Additionally, by the end of 2008 all stand-alone chain or independent pharmacies (known as "true pharmacies") must have adopted an IIAS as well.  Debit cards will continue to be approved for use at all true pharmacy locations through 2008 whether or not the pharmacy has implemented an IIAS yet.

Transactions conducted at most physician offices, hospitals and other health care facilities should not be impacted by this change provided they use a health care merchant category code.

Example¹

Employee A is a participant in the health FSA sponsored by their employer and has contributed $100 to a flexible spending account.  The employee purchases aspirin, antacid and cold medications at one of the IIAS participating merchants.  The total amount for these medications is $20.75.  At the same time, Employee A purchases an additional $50 of items that are not qualified expenses, for a total purchase amount of $70.25.

• What happens if the employee is at one of the IIAS participating merchants? The store’s IIAS compares the SKUs (Stock Keeping Units) from all of the items against the SKUs from a list of qualified reimbursable medical expenses.  The $20.75 in allowable medical expenses is authorized and the remaining $50 is rejected.  Employee A is asked for an additional form of payment to purchase the remaining non-medical items.
  
  
• What happens if the employee is NOT at one of the IIAS participating merchants?  If the merchant is a “true pharmacy” the debit card will continue to be accepted through 2008.  The employee should instruct the cashier to process two transactions: one for the medications in the amount of $20.75 and another in the amount of $50.00 for the non-medical expenses.  The employee should retain the receipt to substantiate the transaction with the FSA/HRA administrator or in the event of an IRS audit.

If the merchant is a grocery, discount or warehouse store and an IIAS has not been implemented, the debit card cannot be used and the employee must pay the cost out-of-pocket. The employee will need to contact their FSA/HRA administrator for information on how to submit a claim for manual reimbursement.

Next Steps -- What Should Employers Do? 

ArlenGroup recommends that employers that offer FSA/HRA debit cards to employees communicate the change before January 1, 2008. 


Additional Information

• IRS Notice 2006-69
• IRS Notice 2007-02

This document is not intended to provide any legal advice or analysis. Please consult your own legal counsel for further information on the topics discussed in this issue of Insight.