Employers will have the legal tools needed to make their account-based health plans both more efficient and more attractive to employees under a new IRS notice. Whether their administrative systems can take full advantage of the new options remains to be seen.

Issued last week, IRS Notice 2006-69 provides: much-anticipated guidance on the use of debit and other electronic payment cards for account-based plans such as health reimbursement arrangements (HRAs) and health flexible spending accounts (FSAs); first-ever guidance on using electronic payment cards for dependent care FSAs; and a potentially important new idea on administering health care accounts, even without electronic payment cards.

Most importantly for employers, the IRS has cleared the legal way for:

  • Administrators of payment card programs to use inventory control information systems to enable employees to buy health care items from a range of merchants (including supermarkets and discount stores), rather than only the pharmacies, doctors’ offices and similar sources approved in earlier guidance.
  • HRA or health FSA administrators to reduce paperwork. Consider a participant who has a $20 copay per office visit. The medical plan administrator could notify the HRA or health FSA administrator, which could then consider this a completed claim and automatically deduct $20 from the participant’s health account, and deposit the copay directly into his or her personal bank account. If both administrators could cooperate and the right systems are in place, this may reduce the need for paper forms and even electronic payment cards.

Notice 2006-69 is generally effective upon its release, except that the inventory information systems standards take effect for plan years starting after 2006.

The Notice supplements a 2003 IRS ruling that gave employers their first detailed guidance on how electronic payment card programs could be structured to comply with the tax rules governing cafeteria plans and self-insured medical reimbursement plans. One of the critical requirements under those tax rules is that every claim be “substantiated.” Unless each claim is substantiated, payments out of the account should be taxable income to a participant.

Under the 2003 ruling, electronic payment card programs could be structured to “automatically” substantiate a number of claims. For example, if certain safeguards were in place, claims from hospitals, pharmacies and other sources with health-related merchant codes would be paid automatically, as would claims that were in the amount of a plan copayment.

Notice 2006-69 modifies the prior IRS rulings on substantiation. As noted above, it expands the range of merchants where participants can use their electronic payment cards and still take advantage of automatic substantiation, and it specifically allows “direct” substantiation by a third party (such as a health plan TPA) rather than an employee.

According to Tim Stanton, a shareholder in Ogletree Deakins’ Chicago office, “Both these opportunities rely heavily on the administrative systems being developed by vendors, which will make services contracts with those vendors even more important.”

In addition, the IRS expanded the ability to automatically substantiate charges for copayments. A charge can now be in the amount of an exact multiple (up to five) of the copayment. This is designed to accommodate situations where a participant picks up multiple medications at one time, or takes several children into the doctor at the same time. Charges beyond five times the copayment amount, or charges that are not in the exact amount of a multiple, would require additional verification.

Emphasizing the need for third-party verification, though, the IRS did clarify that “self-substantiation” or “self-certification” of an expense by an employee-participant – including on a website as a part of an electronic payment program – would not pass muster under the tax rules.

Finally, this Notice gives employers their first detailed guidance on using electronic payment cards for dependent care account expenses. Employers may not see this as an attractive option because many day care providers may not accept electronic card payments. Another obstacle is created by the tax rules themselves. The tax rules on FSAs permit reimbursement only of “incurred” expenses. Even though dependent care providers often require payment upfront, the tax rules do not consider the expenses incurred until the services are actually provided. This means that generally electronic cards could not be used to pay expenses as they come due.

Still, the IRS has sanctioned one way that an employer could use an electronic payment card in its dependent care account program. Essentially, it entails a participant paying his or her initial expenses upfront and then submitting receipts to the plan administrator. Once the plan administrator receives this initial substantiation, it can increase the amount of value on a card and the participant could use the card to pay for future dependent care expenses. Assuming that future card transactions involved the same provider and the same or lesser dollar amount, the later transactions could be treated as automatically substantiated claims and reimbursed without further claims forms.

Additional Information

For further information on this and other employee benefits and executive compensation issues, contact the Ogletree Deakins attorney with whom you normally work or the Client Services Department at 866-287-2576 or via e-mail at clientservices@ogletreedeakins.com.

Note: This article was published in the July 19, 2006 issue of the National eAuthority.

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