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FROM THE OFFICE OF PUBLIC AFFAIRS
September 3, 2003
JS-695
Today, the Treasury Department and the IRS announced over-the-counter drugs can
be paid for with pre-tax dollars through health care flexible spending accounts.
Treasury and IRS issued guidance clarifying that reimbursements for nonprescription
drugs by an employer health plan are excluded from income. Thus, reimbursements by
health flexible spending arrangements (FSAs) and other employer health plans for the
cost of over-the-counter drugs available without prescription are not subject to tax
if properly substantiated by the employee.
"Flexible Spending Accounts are an important tool in helping people meet their
health care costs," stated Treasury Secretary John Snow. "Since many prescription
drugs have moved to the over-the-counter market, this action today makes paying for
them a little bit easier to swallow."
"Flexible Spending Accounts were established under the tax code to provide incentives
for better health care," said IRS Commissioner Mark W. Everson. "This action is a
sensible expansion and simplification of the program consistent with existing law."
Drugs are increasingly becoming available over-the-counter without prescription.
Many health plans no longer cover the cost of these drugs as over-the-counter.
While an over-the-counter drug is less expensive than the prescription drug, the
cost to many consumers increases because the price paid by the consumer for the
over-the-counter drug is greater than the co-payment by the consumer when the drug
was covered by insurance. This is especially an issue for individuals who remedy
chronic health problems by regularly taking an over-the-counter medicine.
Revenue Ruling 2003-102 explains that the statutory exclusion for reimbursements
of employee health expenses is broader than the itemized deduction for medical
expenses (which does not apply to nonprescription drugs). Thus, the guidance
clarifies that employer reimbursements of employee health expenses that are
nonprescription drugs, including reimbursements through health FSAs and Health
Reimbursement Arrangements (HRAs), are excluded from income like other employer
reimbursements of employee health expenses. This will result in savings to consumers
with access to employer plans who may purchase nonprescription drugs. However, for
purposes of the itemized medical expenses deduction, the cost of such over-the-counter
drugs continues to be non-deductible. In addition, the cost of dietary supplements
that are merely beneficial to the employee's health are not excluded from income.
The text of Revenue Ruling 2003-102 follows:
Part 1
Section 105. - Amounts Received Under Accident and Health Plans
(Also Section 213. - Medical, Dental, etc., Expenses)
Rev. Rul. 2003-102
ISSUE
Are reimbursements by an employer of amounts paid by an employee for medicines,
drugs, or dietary supplements purchased by the employee without a physician's
prescription excludable from gross income under § 105(b) of the Internal Revenue
Code?
FACTS
Employer N sponsors a health flexible spending arrangement (health FSA). The
health FSA provides for the reimbursement of participating employees' medical care
expenses that are not covered by other insurance. Employee A is a participating
employee in Employer N's health FSA.
Employee A purchases an antacid, an allergy medicine, a pain reliever, and a
cold medicine from a pharmacy, none of which are purchased with a physician's
prescription. Employee A purchases these items for personal use, or for the use of
Employee A's spouse or dependents, to alleviate or treat personal injuries or
sickness. Employee A also purchases dietary supplements (e.g., vitamins) without a
physician's prescription to maintain the general health of Employee A, or Employee
A's spouse or dependents. Employee A submits substantiated claims for all of these
expenses, which have been incurred during the current plan year, to Employer N's
health FSA for reimbursement. Employee A is not compensated for these expenses by
insurance or otherwise.
LAW AND ANALYSIS
Section 61(a)(1) provides that, except as otherwise provided in subtitle A,
gross income includes compensation for services, including fees, commissions,
fringe benefits, and similar items.
Section 105(a) provides that amounts received by an employee through accident
or health insurance for personal injuries or sickness are included in gross income
to the extent such amounts (1) are attributable to contributions by the employer
that were not includible in the gross income of the employee or (2) are paid by the
employer.
However, § 105(b) provides an exception to the general rule requiring inclusion
in income. Section 105(b) provides that, except in the case of amounts attributable
to (and not in excess of) deductions allowed under § 213 (relating to medical
expenses) for any prior taxable year, gross income does not include amounts paid,
directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses
incurred by the taxpayer for the medical care (as defined in § 213(d)) of the
taxpayer or the taxpayer's spouse or dependents (as defined in § 152).
Section 105(e) states that amounts received under an accident or health plan for
employees are treated as amounts received through accident or health insurance for
purposes of § 105. Section 1.105-5(a) of the Income Tax Regulations provides that
an accident or health plan is an arrangement for the payment of amounts to employees
in the event of personal injuries or sickness.
Section 213(d)(1) defines "medical care" to include amounts paid for the
diagnosis, cure, mitigation, treatment, or prevention of disease, or for the
purpose of affecting any structure or function of the body.
Section 1.213-1(e)(1)(ii) states that an expenditure that is merely beneficial
to the general health of an individual, such as an expenditure for a vacation, is
not an expenditure for medical care. Section 1.213-1(e)(1)(ii) also states that
expenditures for "medicines and drugs" are expenditures for medical care.
Section 1.213-1(e)(2) states that the term "medicine and drugs" includes only
items that are legally procured and generally accepted as falling within the
category of medicine and drugs. Section 1.213-1(e)(2) further provides that
toiletries (e.g., toothpaste), cosmetics (e.g., face creams) and sundry items are
not "medicines and drugs" and that amounts expended for these items are not
expenditures for "medical care."
Rev. Rul. 2003-58, 2003-22 I.R.B. 959, considers whether amounts paid by an
individual for medicines that may be purchased without a prescription of a physician
are deductible under § 213. The ruling notes that § 213(b) permits an amount paid
for a medicine or drug to be taken into account for the purposes of the § 213
deduction for medical care expenses only if the medicine or drug is a prescribed
drug or insulin. Section 213(d)(3) defines a "prescribed drug" as a drug or
biological that requires a prescription of a physician for its use by an individual.
The ruling concludes that amounts paid for medicines or drugs that may be purchased
without a prescription of a physician are not taken into account pursuant to
§ 213(b) and are therefore not deductible under § 213.
Section 105(b) specifically refers to "expenses incurred by the taxpayer for
... medical care," as defined in § 213(d). There is no requirement in § 105(b)
that the expense be allowed as a deduction for medical care under § 213(a) or that
only medicines or drugs that require a physician's prescription be taken into account.
Accordingly, the amount expended by Employee A to purchase the antacid, allergy
medicine, pain reliever, and cold medicine without a physician's prescription is an
expenditure for medical care. Employer N's health FSA reimbursement of Employee
A's cost for these items is therefore excludable under § 105(b), even though the
cost would not have been deductible under § 213(a). However, the dietary
supplements (e.g., the vitamins) are merely beneficial to Employee A or Employee
A's spouse or dependents' general good health. Therefore, the cost of the dietary
supplements is not an expense for medical care and is not reimbursable or excludable
under § 105(b).
HOLDING
Reimbursements by an employer of amounts paid by an employee for medicines and
drugs purchased by the employee without a physician's prescription are excludable
from gross income under § 105(b). However, amounts paid by an employee for dietary
supplements that are merely beneficial to the general health of the employee or the
employee's spouse or dependents, are not reimbursable or excludable from gross
income under § 105(b).
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 2003-58 is distinguished.
DRAFTING INFORMATION
The principal author of this revenue ruling is Barbara E. Pie of the Office of
Division Counsel/Associated Chief Counsel (Tax Exempt and Government Entities).
For further information regarding this revenue ruling, contact Ms. Pie at
(202) 622-6080 (not a toll-free call).
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