IRS Gives Green Light To Debit Cards For Certain Health Plans
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Although benefits debit cards have been around for the past three or four years, with more than half a million currently in circulation, a lot of employers have stayed on the sidelines.
Employers were waiting for the Internal Revenue Service to weigh in on whether use of debit cards satisfied the agencys requirements under Section 125, as well as its substantiation requirements that purchases were only for eligible expenses under Section 213 of the Internal Revenue Code.
As of May 6, the wait was finally over.
In its formal guidance, in Revenue Ruling 2003-43, the IRS said that debit cards (or, more accurately, stored-value cards) can be used for the health reimbursement arrangements (HRAs) offered with consumer-directed group health plans, as well as for flexible spending accounts (FSAs).
What this means, in a nutshell, is that electronic payment systems can, under certain circumstances, replace manual or written systems, paving the way to improved employee convenience and administrative efficiencies with the governments blessing.
Although few who have become familiar with these electronic payment systems doubted the cards could provide administrative efficiencies and convenience, the fundamental question initially was whether they could comply with IRS requirements that cards be used only for IRS-eligible expenses. In the following years, the industry saw new players bring in vastly improved technologies.
When combined with the IRSs recent green light on card use and its specific substantiation requirements, the issue is no longer whether cards can comply. Instead, employers, third-party administrators and other potential buyers are more concerned with how efficient a card vendors processes are in deploying this new payment technology in the employee benefits setting.
In its guidance, the IRS spells out the requirements for electronic substantiation of transactions, among other things. Fortunately, most of the requirements conform to current industry practices. But before we can appreciate where the IRS is going with its new guidance, it helps to look back at where it started.
The Three-Part Test. Before debit cards came along, the IRS used a three-part test to ascertain whether a Section 125 medical expense was eligible for reimbursement.
Each time an expense was incurred, an employee had to sign a statement affirming that the expense was allowed and promising not to seek reimbursement from an insurer for the same expense.
The employee needed a receipt or other third-party statement affirming that the employee had incurred an eligible expense.
An employer or claims administrator had to provide third-party substantiation of everything the employee was claiming along with a determination that the expense was reimbursable.
Although meeting these requirements may seem simple and straightforward, it has been quite paper- and labor-intensive. Thats why debit cards were just what the doctor ordered, as long as the IRS approved of their use.
In an attempt to comply with the first requirement, most stored-value and debit card companies had employees sign a statement prior to using the card affirming that the card would only be used for eligible expenses. And since each card transaction generated a receipt, it was assumed that the second part of the test would be satisfied.
As for third-party substantiation, there was some question as to how the IRS would address electronic substantiation of transactions. The pharmacy represents the one place where card users are most likely to incur ineligible FSA/HRA expenses–yet its also the setting where the majority of transactions occur and therefore critical to making cards acceptable to employers, employees and TPAs.
The most efficient approach to pharmacy transactions is to establish direct technology links with the nations top pharmacy benefit managers, which transmit the adjudicated amount of the eligible prescription directly to the pharmacist. Thats something only one card company has been able to accomplish to date.
When you consider that at least half of all FSA transactions take place in the pharmacy, the reduction or elimination of prescription-related paper can have a major impact on an administrators business, not to mention consumer appeal.
Fortunately, the IRS recognizes much of what already is taking place in the industry. The regulations provide employers and TPAs with enough detail to be able to use stored-value payment technology in ways that benefit both employers and employees.
