Internal Revenue Service Issues Debit Card Ruling

On May 6, 2003, the Internal Revenue Service (IRS) released Revenue Ruling 2003-43 regarding the use of debit/credit/stored-value cards as applied to health FSAs and Health Reimbursement Accounts (HRAs). The good news to many is that the ruling allows for the use of debit cards in relation to health FSA accounts and HRAs, however, it sets out specific rules that must be followed if the debit card is utilized as a reimbursement method. Basically, Revenue Ruling 2003-43 upholds the existing IRS substantiation requirements related to FSAs. That is, the employee must certify that the requested reimbursement is an eligible Section 213 expense and that reimbursement will not be sought from any other source. Also, the claim must be incurred and each claim must be adjudicated. However, the ruling clarifies that the necessary certification, substantiation, and adjudication can occur electronically with certain types of claims if performed in accordance with the steps set out in the ruling. The ruling lays out plan sponsor responsibilities in relation to debit card parameters, correction of mistaken reimbursements, and Form 1099-MISC filing guidance. Finally, the ruling confirmed that the methods of "sampling" and "auditing" are not permissible.

Effective Date:

This ruling takes effect immediately. Note however, that those plans utilizing "sampling" and "auditing" adjudication methods have until the first plan year beginning after December 31, 2003 to cease the "sampling" and "auditing" method.

Certification By Employee:

Each plan year, the participating employee must do the following:

• Certify upon enrollment in the health FSA and HRA, that the debit card will only be used for Section 213 defined medical expenses for the employee, employee's spouse and eligible dependents.
• Certify that any expense paid with the card has not been reimbursed and that the employee will not seek reimbursement from any other source.
• Understand that the certification (which should be printed in the back of the debit card) is reaffirmed each time the card is used.
• Agree to acquire and retain sufficient documentation, including invoices and receipts where appropriate, for any expense reimbursed by the debit card.

Substantiation, Adjudication and Processing of Claims:

Revenue Ruling 2003-43 reiterated what the cafeteria plan regulations have always stated in relation to substantiation, adjudication and processing of claims. That is, each claim must be substantiated and adjudicated. However, these processes may be completed electronically in the following circumstances and the plan may reimburse expenses without further review or submission of a receipt. Electronic processing is acceptable if:

• The transaction took place at an establishment with a merchant code indicating it is the office of a doctor, dentist, pharmacy, or other allowable health care establishment.
• The dollar amount of the transaction at a health care provider equals the dollar amount of the co-payment for that service under the major medical plan of the specific employee utilizing the debit card. For example, an employee is enrolled in a major medical plan with a $20.00 co-pay for a doctor visit and the electronic system matches the amount of the debit card transaction, $20.00, with the co-payment under the employee's medical plan.
• The debit card is used for reimbursement of a recurring expense that matches expenses previously approved regarding amount, provider, and time period. For example, an employee who refills a prescription drug on a regular basis at the same provider for the same amount.
• The service provider, or other independent third-party (e.g., Pharmacy Benefit Manager), at the time of point of sale, provides information to the claims processor that the amount being reimbursed via the debit card is for a medical expense. This communication can be completed by e-mail, the Internet, intranet, or telephone. This process is known as "real-time substantiation."

The ruling states that all other types of charges to a debit card other than those described above are to be treated as conditional reimbursement pending confirmation of the expense. In such instances, the claim processing entity will require the employee to submit the service provider receipts which must include (1) a description of the service or product, (2) the date of the service or sales, and (3) the amount of the expense. This would be the standard paper process most employers currently use.

Correction of Improper Reimbursements:

Should an improper reimbursement (e.g. an ineligible expense) be discovered, Revenue Ruling 2003-43 requires that the plan sponsor take steps to recoup the monies from the incorrectly reimbursed employee. The IRS has outlined the following options:

• Upon identifying an improper reimbursement, the plan may request the employee to pay the plan an amount equal to the improper reimbursement.
• The plan may have the amount of the improper reimbursement withheld from the employee's wages or other compensation to the extent consistent with applicable law.
• The plan must utilize a claims substitution or offset approach to recoup improper reimbursements. For example, an employee is improperly reimbursed $100.00. The plan would deduct the amount of $100.00 from future eligible claims to satisfy the improper reimbursement.
• If all of the preceding actions prove unsuccessful, the employee must still be considered indebted to the plan for the improper reimbursement and such debt must be treated as any other business indebtedness.

In addition to the above actions, the plan must take preventative actions to ensure that further violation of the debit card reimbursement rules do not occur which include denial of access to the debit card until the improper reimbursement is repaid by the employee to the plan.

Plan Sponsor Responsibilities:

The ruling specifically outlines the following responsibilities imposed on the plan sponsor in relation to its choice to adopt debit card technology:

• The employee's use of the debit card is open to the maximum dollar amount of coverage available in the employee's health FSA or HRA.
• The plan limits the debit card's use to Merchant Codes that only relate to health care. Thus the debit card's use is limited to physicians, pharmacies, dentists, vision care offices, hospitals, and other medical care providers.
• When the employee uses the debit card at the point-of-sale, the service provider is paid the full amount of the charge (assuming the employee account balance is sufficient) and the employee's maximum available coverage remaining is reduced by the reimbursed amount.
• The debit card is automatically cancelled at the time of the employee's termination of employment.

IRS Form 1099-MISC Requirements:

The IRS has clarified that under IRS code section 6041, all persons engaged in a trade or business who make payment in the course of their trade or business to another person of $600.00 or more in a taxable year are required to file returns (1099-MISC) with the IRS. These filings notify the IRS of the amount of the payment and the names and addresses of the recipients (i.e. the dentist or doctor). A Form 1099-MISC must also be provided to the recipient.

Generally, payments made to physicians or other suppliers/providers of medical or health care services (on behalf of an employee) are subject to the Form 1099-MISC reporting requirement. There is generally no reporting requirement if the payment is made to a tax-exempt hospital or to a hospital owned and operated by the United States government and there is generally not a need to report payments to pharmacies for prescription drugs.

In relation to Form 1099-MISC requirements, Revenue Ruling 2003-43 states the following:

"…payments made to medical service providers through the use of debit, credit, and stored-value cards are reportable by the Employer on Form 1099-MISC under § 6041."

Your legal counsel or tax advisor should be involved in helping you determine the extent to which this Form 1099-MISC requirement applies to your business.

Please Note: The provision of the 1099-MISC to the IRS and the recipient is required when the aggregate amount of all claims paid to the recipient for the calendar year for all plan participants exceeds $600.00 or more. For example, Bill and Sue are both employees of XYZ Corp. Bill uses his FSA debit card to pay for $400.00 worth of services at his eye doctor, Dr. Jones. Sue also uses Dr. Jones and used her FSA debit card to pay for $300.00 worth of eye care services. Even though neither Bill nor Sue have used the card for $600.00 or more in relation to Dr. Jones' services, Bill and Sue's employer must issue a Form 1099-MISC to the IRS and to Dr. Jones for the cumulative amount Bill and Sue spent ($700.00) because it exceeds $600.00.

It is interesting to note, however, that some employers argue that debit card payments are made directly to providers by the participant (not the employer) through a participant owned debit account. If this argument is made, perhaps a Form 1099-MISC requirement would not arise. The real issue under this argument is who is contractually obligated to pay the medical care provider - under many credit/debit agreements; the obligation falls upon the participant. Note that this is not legal advice - this is a summary of an argument that some experts are setting out in relation to Forms 1099-MISC. ProBusiness does not, and cannot offer legal advice or practice law. Again, for legal advice upon which you can rely, you must involve your legal counsel or tax advisor so they can help you determine how the law applies to your particular set of facts.

"Sampling" and "Auditing" Techniques NOT Allowed:

The IRS guidance confirms that "sampling" and "auditing" techniques are not allowable adjudication methods for the reimbursement of cafeteria plan expense whether that expense is reimbursed using traditional adjudication methods or debit card technology. The ruling specifically states that "for plan years beginning after December 31, 2003", expenses reimbursed by the "sampling" and "auditing" methods "are not excludable from gross income under § 105(b)."

Example of "Sampling"

Only claims over a specified dollar amount (e.g. $100.00) are adjudicated and claims under this specified amount (e.g. $100.00 or less) are automatically paid without the substantiation required by law.

Example of "Auditing"

Only a certain percentage (e.g. 20%) of claims would be selected for adjudication and all others not selected for adjudication (e.g. 80%) would be processed without the substantiation required by law.

SUMMARY:

It is welcome news to most that debit/credit/stored-value cards have now been certified as acceptable for use for FSA and HRA reimbursement purposes and it is also good news that the IRS has been fairly clear with their requirements attached to using debit card technology. There are a few difficulties associated with the use of the debit card, including possible Form 1099-MISC filing requirements, but overall, if the rules are followed, this ruling will make the process more convenient for many participants and may subsequently increase employee participation in health FSAs.

New COBRA Notice Proposed Regulations
Released May 28, 2003

The Department of Labor (DOL) has released proposed regulations in relation to the notices required under the Consolidated Omnibus Budget and Reconciliation Act (COBRA). These proposed rules set minimum standards for the timing and content of the notices required under COBRA and establish standards for administering the notice process as well as samples of required language regarding the notices. An example of the type of issues addressed in these proposed regulations is that the current regulations require each group health plan covered under COBRA to provide a written notice "at the time of commencement of coverage" to each covered employee and spouse (if any) of the employee. The new proposed regulations establish a 90-day period for the furnishing of the general notice, beginning with the date on which the covered employee or spouse first becomes covered under the plan.

There is not an effective date set out for these proposed regulations, but the DOL must receive written comments by July 28, 2003. These proposed regulations, if finalized, would affect administrators of group health plans, participants and beneficiaries (including qualified beneficiaries) of group health plans, and the sponsors and fiduciaries of such plans. ProBusiness is in the process of an in-depth analysis of the proposed regulations.

ProBusiness will keep you informed of the DOL's progress in relation to receiving and hearing comments and eventually finalizing these proposed regulations. Look for more information in future issues of TechFlex!

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Please contact ProBusiness for further information at:
20000 North Creek Parkway, Suite 200, Bothell, WA 98011
Phone: (425) 415-4000 Fax: (800) 269-5231
e-mail: bsa@probusiness.com

(ProBusiness does not make any representation or warranty that the information contained in this newsletter, when used in a specific and actual situation, meets applicable legal requirements. This newsletter should not be construed as legal advice. Your legal counsel should be consulted on all specific fact situations.)

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