Reimbursement of Over-The-Counter Drug Costs

The Internal Revenue Service (IRS) recently issued a revenue ruling in which it provides that over-the-counter (OTC) drugs can now be paid for with pre-tax dollars through health care flexible spending accounts (FSAs). This change is particularly important in light of the many prescription drugs that have moved to the OTC market and the fact that most health plans do not cover OTC drugs. Many drugs have become expensive to consumers who must pay more for the OTC than they did for the copayment when the drug was prescribed.

Under the ruling, the IRS holds that the statutory exclusion for reimbursements of employee health expenses in the Internal Revenue Code (Code) is broader than the itemized deduction for medical expenses provided under the Code, which does not generally apply to OTC drugs. Noting that the cost of OTC drugs continues to be nondeductible for purposes of the itemized medical deduction, the IRS differentiated this ruling from a prior one in which it ruled that only insulin and prescription medicines are eligible for the itemized deduction under the Code.

The ruling notes that dietary supplements such as vitamins, which are merely beneficial to general health, are not proper items for reimbursement from an FSA or excludable from gross income. In addition, the IRS notes that toiletries, cosmetics, and sundry items do not qualify as expenditures for medical care eligible for reimbursement or exclusion from income.

The ruling is scheduled for publication in Internal Revenue Bulletin 2003-38, which will be dated September 22, 2003. However, it appears that sponsors of FSAs may rely on the ruling now to reimburse the cost of OTC drugs.

Reimbursement will still be subject to the substantiation requirements for FSAs. That is, a written statement must be provided from an independent third party stating that the expense has been incurred and the amount of the expense. The employee must provide a written statement that the expense has not been reimbursed or is not reimbursable under any other health plan coverage. Pharmacies, however, may now need to provide customers with more detailed information indicating the specific OTC drug that has been purchased rather than simply a cash receipt for the amount paid.

Some flexible benefits plans (cafeteria plans or 125 plans) may need to be amended to allow for the reimbursement of OTC drugs. If you have any questions about reimbursement under your plan, please do not hesitate to contact us.