IRS makes FSA debit cards easier to use

HR Magazine, Sept, 2006 by Allen Smith

A recent Internal Revenue Service (IRS) notice should popularize the use of debit cards for flexible spending accounts (FSAs), according to Patty Cain, chair of Neal, Gerber & Eisenberg's Employee Benefits & Executive Compensation Practice Group.

The notice outlines new ways in which debit card transactions may be substantiated automatically, which should make them more convenient by resulting in real-time payment from FSAs. In addition, the guidance should make it easier to use debit cards for dependent care assistance programs (DCAPs) as well as health reimbursement accounts, she noted.

Debit cards aren't new to FSAs, Cain pointed out, estimating that 6 million debit cards are linked to FSAs. And automatic substantiation of FSA debit cards predated the notice.

However, IRS Ruling 2003-43 in 2003 limited the automatic substantiation of co-payments by FSA debit cards to a single co-payment each swipe, she said. The July 11 notice (Notice 2006-69) permits automatic substantiation for multiple co-payments up to five times the maximum co-payment.

So how will that play out? Suppose that an employee participates in an employer medical plan that has a $5 co-payment for generic prescriptions and a $10 co-payment for all other prescriptions. If she uses an FSA debit card at a pharmacy to purchase five non-generic prescriptions for a total card transaction of $50, the transaction is substantiated without further review or documentation, according to the new notice. (The co-payment match substantiation method is permitted only at merchants or service providers that have health care-related merchant category codes.)

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What if the worker uses the FSA debit card at a pharmacy to purchase three generic prescription and three non-generic prescriptions for a total card transaction of $45? Because the transaction is an exact match of a combination of the co-payments and does not exceed five times the maximum co-payment, this transaction also would be substantiated automatically.

But what if she purchases two non-generic prescriptions and a nonprescription medication and the amount of the transaction is $27? Because the transaction amount is not an exact match of a multiple or combination of the co-payments, the transaction must be further substantiated by submitting a receipt to the administrator.

Co-payments often are in increments of $5 or $10 and are not taxed, Cain noted. Very rarely will other items in a drugstore be exact multiples of the co-payment.

The IRS notice also notes that the payment card processor may provide a system with merchants for approving and rejecting card transactions through inventory control information, such as stock-keeping unit (SKU) numbers. Products' SKU numbers may be checked against a list of eligible expenses.

This method has recordkeeping requirements, Cain noted. She said that employers, in addition to third-party administrators, should have access to records under this system.

In addition, a claim may be substantiated fully without the need for a receipt from an employee if an independent third party provides information, such as explanation of benefits from an insurance company, indicating:

* The date of the FSA service.

* The employee's co-insurance payments.

* Amounts below the plan's deductible.

Cain said she expects that financial institutions in the debit card business will market to employers to encourage them to take advantage of the new flexibility from the recent IRS notice. She urged employers to "do due diligence" to make sure that the way any third party offers to implement a debit card program will follow the IRS notice.

One wrinkle with using debit cards to pay for day care from DCAPs is that, under the notice, automatic substantiation is possible only after a service has been performed, Cain stated.

So, an employee would have to pay a day care center out of pocket and then establish entitlement from the DCAP before the employee could use the debit card, she hypothesized. This initial hurdle may be a more difficult concept for employees to understand.

It is unclear how the debit card would work if an individual provides day care or if someone runs a day care business from home, Cain added.

ALLEN SMITH, J.D., IS SHRM'S MANAGER OF WORKPLACE LAW CONTENT.