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 Treasury and IRS Announce over-the-counter Drugs to be covered by Health Care Flexible Spending Accounts




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 to 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. 

The text of Revenue Ruling 2003-102 follows:

Part 1

Section 105. - Amounts Received Under Accident and Health Plans
(Also Section 213. - Medical, Dental, etc., Expenses)

Rev. Rul. 2003-102


 Are reimbursements by an employer of amounts paid by an employee for medicines, drugs, or dietary supplements purchased by the employee without a physician's prescription excludable from gross income under � 105(b) of the Internal Revenue Code?


 Employer N sponsors a health flexible spending arrangement (health FSA).  The health FSA provides for the reimbursement of participating employees' medical care expenses that are not covered by other insurance.  Employee A is a participating employee in Employer N's health FSA.

 Employee A purchases an antacid, an allergy medicine, a pain reliever, and a cold medicine from a pharmacy, none of which are purchased with a physician's prescription.  Employee A purchases these items for personal use, or for the use of Employee A's spouse or dependents, to alleviate or treat personal injuries or sickness.  Employee A also purchases dietary supplements (e.g., vitamins) without a physician's prescription to maintain the general health of Employee A, or Employee A's spouse or dependents.  Employee A submits substantiated claims for all of these expenses, which have been incurred during the current plan year, to Employer N's health FSA for reimbursement.  Employee A is not compensated for these expenses by insurance or otherwise.


 Section 61(a)(1) provides that, except as otherwise provided in subtitle A, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items. 

 Section 105(a) provides that amounts received by an employee through accident or health insurance for personal injuries or sickness are included in gross income to the extent such amounts (1) are attributable to contributions by the employer that were not includible in the gross income of the employee or (2) are paid by the employer.

 However, � 105(b) provides an exception to the general rule requiring inclusion in income.  Section 105(b) provides that, except in the case of amounts attributable to (and not in excess of) deductions allowed under � 213 (relating to medical expenses) for any prior taxable year, gross income does not include amounts paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by the taxpayer for the medical care (as defined in � 213(d)) of the taxpayer or the taxpayer's spouse or dependents (as defined in � 152).

 Section 105(e) states that amounts received under an accident or health plan for employees are treated as amounts received through accident or health insurance for purposes of � 105.  Section 1.105-5(a) of the Income Tax Regulations provides that an accident or health plan is an arrangement for the payment of amounts to employees in the event of personal injuries or sickness.

 Section 213(d)(1) defines "medical care" to include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.

 Section 1.213-1(e)(1)(ii) states that an expenditure that is merely beneficial to the general health of an individual, such as an expenditure for a vacation, is not an expenditure for medical care.  Section 1.213-1(e)(1)(ii) also states that expenditures for "medicines and drugs" are expenditures for medical care.

 Section 1.213-1(e)(2) states that the term "medicine and drugs" includes only items that are legally procured and generally accepted as falling within the category of medicine and drugs.  Section 1.213-1(e)(2) further provides that toiletries (e.g., toothpaste), cosmetics (e.g., face creams) and sundry items are not "medicines and drugs" and that amounts expended for these items are not expenditures for "medical care."

 Rev. Rul. 2003-58, 2003-22 I.R.B. 959, considers whether amounts paid by an individual for medicines that may be purchased without a prescription of a physician are deductible under � 213.  The ruling notes that � 213(b) permits an amount paid for a medicine or drug to be taken into account for the purposes of the � 213 deduction for medical care expenses only if the medicine or drug is a prescribed drug or insulin.  Section 213(d)(3) defines a "prescribed drug" as a drug or biological that requires a prescription of a physician for its use by an individual.  The ruling concludes that amounts paid for medicines or drugs that may be purchased without a prescription of a physician are not taken into account pursuant to � 213(b) and are therefore not deductible under � 213.

 Section 105(b) specifically refers to "expenses incurred by the taxpayer for . . . medical care," as defined in � 213(d).  There is no requirement in � 105(b) that the expense be allowed as a deduction for medical care under � 213(a) or that only medicines or drugs that require a physician's prescription be taken into account. 

 Accordingly, the amount expended by Employee A to purchase the antacid, allergy medicine, pain reliever, and cold medicine without a physician's prescription is an expenditure for medical care.  Employer N's health FSA reimbursement of Employee A's cost for these items is therefore excludable under � 105(b), even though the cost would not have been deductible under � 213(a).  However, the dietary supplements (e.g., the vitamins) are merely beneficial to Employee A or Employee A's spouse or dependents' general good health.  Therefore, the cost of the dietary supplements is not an expense for medical care and is not reimbursable or excludable under � 105(b). 


 Reimbursements by an employer of amounts paid by an employee for medicines and drugs purchased by the employee without a physician's prescription are excludable from gross income under � 105(b).  However, amounts paid by an employee for dietary supplements that are merely beneficial to the general health of the employee or the employee's spouse or dependents, are not reimbursable or excludable from gross income under � 105(b).


Rev. Rul. 2003-58 is distinguished.


 The principal author of this revenue ruling is Barbara E. Pie of the Office of Division Counsel/Associated Chief Counsel (Tax Exempt and Government Entities).  For further information regarding this revenue ruling, contact Ms. Pie at (202) 622-6080 (not a toll-free call).


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