PPACA changes the rules for Flexible Spending Accounts, is fighting that change justifiable?

There is much to worry about with respect to health care reform and the Patient Protection Affordable Care Act. Anyone who reads this blog knows I am surely worried, mostly about costs. I am less worried about what amount to minor annoyances. On the other hand, if you have a vested interest, perhaps they are not so minor. Such is the case with the flexible spending account. Groups such as the Employers Council on Flexible Compensation (ECFC) (I was once a member) and groups that administer FSAs are concerned about PPACA changes. They are mounting a campaign (see the logo at the bottom right of this page for a link to their website) to have Congress repeal two offending provision of PPACA. One limits the amount placed in an FSA to $2500 a year and the other requires a prescription to be reimbursed for over the counter drugs.

Annoying yes, harmful to a relatively few people yes, but where do we get the $18 billion or so that has been counted as savings for these provisions of PPACA?

These and many similar efforts to change PPACA to favor one group or another point out the near total inability we have to come to a consensus on this problem of health care costs. We all want to control costs as long as there is no additional burden on us.

The truth is that the IRS added coverage for OTC items in 2003. The stated logic for adding this coverage still stands. It is also clear that the PPACA change was not logical but revenue driven. It is hard to argue with that.

The new limit of $2,500 permitted annually in an FSA is troublesome but not devastating. The limit will increase out-of-pocket costs for individuals with large deductibles and high medical bills. It will increase costs for families with high dental bills especially orthodontic expenses. It will also increase costs for people who use FSAs to help pay for vision related services and glasses. On the other hand, actual FSA use is modest with the average employee contribution far less than the new $2500 limit

An April 2010 analysis by consultant Hewitt Associates (now AonHewitt) drew on the firm’s database of more than 220 U.S. employers covering more than 6 million employees.

Among the findings:

Few employees currently contribute to FSA accounts:

• Only 20 percent of U.S. employees contributed to an FSA in 2010, either because they were not offered by their employer, or in large part because of concerns over the “use it or lose it” rule requiring them to forfeit unspent contributions each year.
• Employees who participate typically save between $250 and $640 each year in federal taxes.
• Three-quarters of FSA expenses are for prescription drugs and medical treatments.

Most employees contribute significantly less than the upcoming $2,500 maximum limit:

• Of those employees who contribute to an FSA, the average annual contribution is $1,441.
• 18 percent of workers contributed more than $2,500 and tended to be individuals earning more than $150,000 a year.
OTC drugs make up a small portion of overall FSA spending:
• Around 7 percent of all FSA claims in 2009 were for OTC drugs

Clearly, FSAs are helpful to some Americans. Unfortunately, a small portion of the workforce has an FSA available and even fewer use them to full advantage. While one can argue they favor higher income Americans (not millionaires in my definition), they also benefit lower-income workers in part because they allow reimbursement of the full amount selected for the account even before the money is deducted from ones pay. This improves the cash flow for many people who would have a difficult time coming up with the cash at the point of service.

The FSA is one of many tax benefits available to working Americans (remember there is also a Dependent Day Care version of the FSA). A segment of the population benefits from all of these programs. The real question is how we set our priorities on what we can truly afford. I would have liked to see the FSA left untouched and promoted for wider use, but that flies in the face of fiscal reality.

Is seeking to change PPACA with regard to the medical FSA, a fight worth having, can it be justified?

Here is the IRS press release with regard to OTC reimbursement:

Over-the-Counter Drugs To Be Covered by Health Care Flexible Spending Accounts

IR-2003-108, Sept. 3, 2003

WASHINGTON — Today, the Treasury Department and the IRS announced over-the-counter drugs can be paid for with pre-tax dollars through health care flexible spending accounts. Treasury and IRS issued guidance clarifying that reimbursements for nonprescription drugs by an employer health plan are excluded from income. Thus, reimbursements by health flexible spending arrangements (FSAs) and other employer health plans for the cost of over-the-counter drugs available without prescription are not subject to tax if properly substantiated by the employee.

“Flexible Spending Accounts are an important tool in helping people meet their health care costs,” stated Treasury Secretary John Snow. “Since many prescription drugs have moved to the over-the-counter market, this action today makes paying for them a little bit easier to swallow.”

“Flexible Spending Accounts were established under the tax code to provide incentives for better health care,” said IRS Commissioner Mark W. Everson. “This action is a sensible expansion and simplification of the program consistent with existing law.”
Drugs are increasingly becoming available over-the-counter without prescription. Many health plans no longer cover the cost of these drugs as over-the-counter. While an over-the-counter drug is less expensive than the prescription drug, the cost for many consumers increases because the price paid by the consumer for the over-the-counter drug is greater than the co-payment by the consumer when the drug was covered by insurance. This is especially an issue for individuals who remedy chronic health problems by regularly taking an over-the-counter medicine.

Revenue Ruling 2003-102 explains that the statutory exclusion for reimbursements of employee health expenses is broader than the itemized deduction for medical expenses (which does not apply to nonprescription drugs). Thus, the guidance clarifies that employer reimbursements of employee health expenses that are nonprescription drugs, including reimbursements through health FSAs and Health Reimbursement Arrangements (HRAs), are excluded from income like other employer reimbursements of employee health expenses. This will result in savings to consumers with access to employer plans who may purchase nonprescription drugs.
However, for purposes of the itemized medical expenses deduction, the cost of such over-the-counter drugs continues to be non-deductible. In addition, the cost of dietary supplements that are merely beneficial to the employee’s health are not excluded from income.

Rev. Rul. 2003-102 will be published in Internal Revenue Bulletin 2003-38, dated Sept. 22, 2003.
Related Item: Rev. Rul. 2003-102 (PDF 46K)

Related Articles

• IRS Backs Off Debit Card Ban for OTC Drugs (foxnews.com)
• Over-the-counter meds to be cut from flexible spending accounts (msnbc.msn.com)
• How Healthcare Reform Will Change the Way You Pay Taxes (turbotax.intuit.com)