Changes in the Flexible Spending Account (FSA), no logic, plenty of cost shifting

The Flexible Spending Account (FSA) was created in 1978, when Section 125 was added to the Internal Revenue Code.  This section allows individuals to elect tax-free benefits in lieu of taxable cash in their pay. Over the years, many employers (about 26 percent) added this option to their employee benefits program.  Both the employer and the employee save money, albeit at taxpayers’ expense. Approximately 35 percent of eligible employees use the FSA when available. According to a Mercer Consulting study, the average employee contribution to an FSA is $1,235 (2005).    

In 2003, the IRS issued a revenue ruling stating that over-the counter medication may be reimbursable through a health FSA. The action was prompted because some medications previously requiring a prescription became available over-the counter, Claritin for example. The reasoning was that the drug was still a reimbursable medical expense.    

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Hey pal, we did it again.  Do you think anyone will ever check the numbers?    

In the quest to make it appear that the Patient Protection Affordable Care Act PPACA was being paid for, Congress changed the rules for the FSA.    

Under the law, effective beginning in 2011, the cost of over-the-counter medicines may not be reimbursed with funds through an HSA, FSA, HRA, or Archer MSA, unless a physician prescribes the medicine (or unless it is insulin). The provision is estimated to raise $5 billion in revenue over 10 years.  

2010-59 and Revenue Ruling 2010-23. Employers should read these carefully. -Notice FSAs changes to PPACAOn September 3, 2010, the Internal Revenue Service (“IRS”) issued two pieces of guidance to implement the

• Even if the OTC expense is incurred during the permissible 2 ½ month grace period for FSAs, it may not be reimbursed from the FSA 
• OTC expenses may be reimbursed on or after January 1, 2011, so long as the expenses subject to reimbursement were incurred prior to January 1, 2011 
• The IRS makes it clear that prescription” means “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.” 
• The January 1, 2011 effective date applies regardless of whether the applicable plan is a calendar year plan. 

Let’s think about this.  The IRS’s logic of 2003 is still valid and more medications once prescription only are now available over the counter so logically there was no reason to change the law. Further, to continue to have an over-the counter medication eligible for an FSA or similar arraignment, all one has to do is get his doctor to write a script, i.e. “take an aspirin every day, take Claritin for your allergy.”  I hope that this is done on the phone otherwise; we may be adding office visit costs to health insurance simply to have an over-the counter medication continue eligible for the FSA.    

However, there is even more faulty logic in all this.  For the government to save money, the total amount placed into the FSA must be decreased.  Assume an employee places $1,000 into an FSA each year.  Typically, at the end of the year if there is money left the employee will use the funds on miscellaneous expense, like a pair of glasses or over-the counter medicine for the following year.  Of course, in some cases OTC medication is used regularly will be purchased throughout the year.    

Nevertheless, since the pre-tax money in the FSA is forfeited if not used by year-end and thus remains free from taxes, for there to be a tax savings for the government, the employee will have to reduce that $1,000 contribution before the start of the year.  Since medical expenses are unpredictable and employee out-of-pocket costs are rising, is it logical to assume that the average person will look at that $1,000 and say, “gee, I can’t use that money for my cough medicine or aspirin, I’m going to change the $1,000 to $978 next year?”  Don’t count on it.    

Therefore, if the employee leaves the $1,000 election in place, the government loses the taxes on that amount regardless of whether the employee is reimbursed the full amount or forfeits the $22.00 he would have spent on OTC medication.    

Beginning in 2013, the law limits pre-tax contributions to an FSA to $2,500 annually. The limit is indexed to inflation after 2014. Given the average contribution is far below $2,500, the average person is not affected.  On the other hand, the family trying to pay for orthodontics for a couple of children or the person with a high deductible and large medical expenses or the family with everyone wearing glasses will find their out-of-pocket costs going up as a result of this change. Given the new limit and the average contribution one has to wonder how the Joint Committee on Taxation (JCT) estimates the provision will raise $13 billion over 10 years.    

We should be wondering (and worrying) about the consequences of a number of provisions of the PPACA.