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A New Standard for Medical Expenses

TaxAlerts Tax Article

September 2010 | Written by: Karen Reed, EA

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A provision in the Affordable Care Act is bringing a change to medical expenses that may be reimbursed with tax–free distributions from flexible spending arrangements (Health FSA’s) and health reimbursement arrangements (HRA’s). Beginning January 1, 2011, amounts paid for over–the–counter medicines and drugs will be allowed to be reimbursed by FSAs and HSAs only if they are purchased with a prescription. Insulin will still qualify for reimbursement whether or not it is purchased with a prescription.

Under a separate provision in the Affordable Care Act, similar rules also apply to distributions health savings accounts (HSA's) and Archer Medical Savings Accounts (Archer MSA’s). A distribution from an HSA or an Archer MSA for a medicine or drug will be considered tax–free only if the medicine or drug requires a prescription, is an over–the–counter medicine or drug for which a prescription was obtained, or is insulin. If beginning in 2011 the account owner buys and pays for nonqualified medicines or drugs with distributions from HSA’s or Archer MSA’s, the amounts for these items could be included in gross income and subject to 20% additional tax.

Previously, amounts paid for medicine whether prescribed or over–the–counter were tax–free if the expenses were reimbursed or paid for from FSA’s, HRA’s, HSA’s, or Archer MSA’s.

The new standard still differs from the definition of a prescription necessary to claim the medical and dental expense deduction as an itemized deduction, which defines a prescribed drug as a drug that requires a prescription for its use. In contrast, for these new provisions, a prescription is defined 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 and that is issued by an individual who is legally authorized to issue a prescription in that state.

Prescriptions are not required for items and supplies that are not medicines or drugs. For example, crutches, bandages and diagnostic devices such as blood sugar test kits will still qualify for reimbursement if they were purchased without a prescription as long as they are necessary for medical care.

To prove that they have purchased over–the–counter medicines with a prescription, taxpayers will need to provide a receipt showing the date and sale amount of the expense as well as documentation that shows that a prescription has been issued, such as an Rx number or a copy the prescription.

Beginning on January 15, 2011, most pharmacies and merchants will no longer accept payment by HSA, FSA and HRA debit cards for over–the–counter medicines unless the purchaser has a valid prescription.