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Health Care Reform: New Prescription Requirements for OTC Medicines and
Drugs to Impact Administration of FSAs, HRAs and HSAs Recently, the Internal Revenue Service issued Notice 2010-59 (the "OTC Notice"), which clarifies the limitation imposed by the Patient Protection and Affordable Care Act (PPACA) on the eligibility of over-the-counter (OTC) drugs and medicines for tax-free reimbursement under an employer-sponsored health plan. Section 9003 of PPACA requires that, beginning January 1, 2011, OTC medicines and drugs (other than insulin) must be "prescribed" to qualify as "medical care" for purposes of employer-sponsored health plans (including Health FSAs and HRAs) and Health Savings Accounts (the "OTC Rule"). This change will have a significant impact on the way that OTCs are purchased and used by individual consumers. In fact, some predict that healthcare costs could increase as individuals schedule physician office visits to get "OTC prescriptions," or alternatively, opt for more expensive "prescription-only" medications to ensure coverage under their plans. At a minimum, the OTC Notice will cause a great deal of confusion for health plan participants (and could overwhelm pharmacists with questions on the application of new law) as participants migrate to the back of the store to have their OTC prescriptions filled. Health debit card systems will need to be reprogrammed, and third-party administrators (TPAs) must employ new procedures to ensure that the OTC prescription requirement is satisfied. The OTC Notice answers a number of questions arising under the new OTC prescription requirement, including:  When is a medicine or drug considered "prescribed"? In other words, is a physician's recommendation enough, or must all of the requirements applicable under state law for a valid prescription be satisfied?  What type of substantiation is required to ensure that a medicine or drug available OTC has actually been "prescribed?"  How does the new OTC Rule's effective date affect plans and employee FSA elections that are already in place (e.g., plans that have fiscal plan years or calendar year plans with grace periods)?  How does the OTC Rule impact the use of health debit cards to purchase OTC medicines and drugs?
Understanding the New OTC Rule and the OTC Notice
The basic rule
Section 9003 of PPACA provides that expenses for OTC drugs or medicines (other than insulin) incurred on or after January 1,
2011, will only be considered "medical care" for purposes of Code Sections 105 and 106 (health plans, including Health FSAs and
HRAs), 220 (Medical Savings Accounts) and 223 (Health Savings Accounts) if they are "prescribed."
What is a medicine or drug?
The determination as to whether a particular OTC item is a medicine or drug is important because the new rules do not apply to
OTC medical supplies and equipment, such as contact lens solutions, bandages, crutches or durable medical equipment or
diagnostic devices such as blood sugar test kits. Such OTC items may continue to be purchased without a prescription, and once
such items are identified, currently compliant health debit card systems can continue to operate as they do today with respect to
such items.
Unfortunately, the OTC Notice does not provide further guidance as to what is a "medicine or drug." Existing guidance under IRS
regulation 1.213-1(e)(2) is circular, providing that "medicine or drug" includes any items that are "generally accepted as falling
within the category of medicine and drugs." However, insulin is not a medicine or drug for purposes of this rule.
Health Care Reform: New Prescription Requirements for OTC Medicines and
Drugs to Impact Administration of FSAs, HRAs and HSAs When is a medicine or drug (other than insulin) considered "prescribed" for purposes of the OTC Rules?
The OTC Notice clarifies that an OTC drug is considered prescribed for purposes of the new rule if the individual obtains a
"prescription" for such medicine or drug (even though a prescription is not legally required to obtain the medicine or drug). A
prescription is defined as an electronic or written 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 authorized to issue a prescription in that
state.
Example #1
Erik lives in Pennsylvania. On January 2, 2011, Erik has pain and swelling in his left shoulder. He goes to his physician, who
recommends that Erik take two Aleve and call him in the morning. Erik purchases a bottle of Aleve for $5.67. On January 3,
2011, he submits the receipt for Aleve to his FSA administrator. The FSA administrator must deny the claim because Erik did
not obtain a prescription for the Aleve. A general physician recommendation (oral or otherwise) that does not satisfy state law
will not qualify as a prescription.
Example #2
Same facts, except that Erik's physician actually writes Erik a "prescription" for prescription-strength naproxen (the "NSAID"
class medicine in Aleve). Since the expense was incurred in Pennsylvania, the prescription must satisfy Pennsylvania's
requirements for prescriptions for the naproxen to be reimbursable. If we assume that Pennsylvania requires, among other
things, that the prescription identify the name and quantity of the drug, and that it be signed (if in writing) and issued by
certain medical practitioners (e.g., a physician). If all of the applicable state law requirements are satisfied, Erik can be
reimbursed for the naproxen under his FSA plan.
Note: The OTC Notice prerequisite that state law requirements for a prescription be satisfied is somewhat awkward in that it
requires application of state rules for tax purposes that are NOT required to be satisfied for an individual to purchase a
medication—since the medicine is available OTC, after all. Most TPAs are not accustomed to monitoring, and ensuring
compliance with, the prescription rules applicable under each state's laws. Nevertheless, the OTC Notice provides a
substantiation solution that will ease administration of this otherwise burdensome compliance requirement. See "What
substantiation is required for OTC drugs or medicines" below for more details.

What substantiation is required for OTC drugs or medicines (other than insulin)?
The OTC Notice indicates that proper substantiation is provided if the participant provides either of the following:
 a receipt from the pharmacy that identifies the purchaser (or the individual to whom the prescription was issued), the date, the amount and the Rx number; or  any other "traditional" manual substantiating documentation without an Rx number (e.g., a sales receipt that identifies the medicine or drug, amount and date purchased), provided the prescription from an authorized issuer is provided. The first method of substantiation, consistent with prior informal IRS advice, allows the TPA to use the Rx number as a proxy for eligibility under Section 213. Under the latter method, the participant can apparently pick up the OTC and pay for it at the front of the store with no pharmacist interaction, but then the burden falls on the TPA to ensure that that the prescription satisfies the Health Care Reform: New Prescription Requirements for OTC Medicines and
Drugs to Impact Administration of FSAs, HRAs and HSAs applicable requirements for a prescription in the state in which the expense was incurred. In either case, the physician must
actually prescribe the drug, but in the latter case the prescription apparently need not be "filled" by a pharmacist.
TPAs may find it difficult, if not impossible, to track "prescription" requirements in each state. Therefore, many TPAs may decide
to limit approved substantiation to a receipt from the pharmacy with the Rx number unless other ways to ensure that the
prescription meets applicable state requirements can be found.
What is the impact of the OTC Notice on use of debit cards to purchase OTC drugs or medicines?
The OTC Notice states that current health debit card systems are "not capable of substantiating compliance with the [new OTC
requirement]." With limited exceptions, the Notice concludes that health FSA and HRA debit cards may not be used to purchase
OTC medicines or drugs on and after January 1, 2011 (subject to the January 15 transition period discussed below). Unless the
designs for debit cards are changed to substantiate the prescription before reimbursement is made, the use of such debit cards
will be restricted.
Interestingly, compliant cards may be used at certain pharmacies and drug stores that qualify as "90% Merchants" (90% of gross
receipts include items that qualify as medical care expenses (including OTC items) under Code Section 213(d) during the prior
taxable year).
Participants may use debit cards for eligible OTC medical items other than medicines or drugs.
Note: The OTC Notice indicates that the IRS will not challenge the use of debit cards for OTC drugs and medicines through
January 15, 2011, provided certain requirements set forth in the applicable debit card guidance (e.g., Notice 2006-69) are
satisfied.
What is the effective date of the new OTC Rule?
The new rule applies for OTC medicines or drugs (other than insulin) incurred on or after January 1, 2011, without regard to the
plan year of the plan. Thus, a plan with a fiscal plan year must begin complying with the rule mid-plan year.
Example
ABC sponsors a health FSA with an October 1 through September 30 plan year. Erik purchases Claritin on December 1,
2010, without a prescription. He submits his reimbursement request and is subsequently reimbursed. On January 2, 2011
(same plan year), Erik again purchases Claritin without a prescription. He submits his request for reimbursement, but this
time, it is denied because he did not obtain a prescription.
Note: Can Erik change his health FSA election as a result of the new rule? Although the OTC Notice does not specifically
address election changes, a literal interpretation of the existing change rules and recent, informal remarks from Treasury
officials would suggest that Bob could not change his election solely as a result of the rule change.
Also, expenses for OTC drugs and medicines incurred during the two-and-a-half-month grace period following the end of a 2010 calendar plan year must be accompanied by a prescription. Health Care Reform: New Prescription Requirements for OTC Medicines and
Drugs to Impact Administration of FSAs, HRAs and HSAs Note: OTC drugs purchased prior to January 1, 2011, may be reimbursed tax-free on or after that date. Thus, if an HSA
participant purchases OTC drugs or medicines in 2010 without a prescription, but does not take an HSA distribution for such
expenses until 2011, the distribution in 2011 is still tax-free (so long as the expenses were otherwise for medical care).
Do cafeteria plans and HRAs need to be amended?
The OTC Notice states that plans that previously covered OTC drugs or medicines must be amended to reflect the new OTC Rule.
Fortunately, the OTC Notice allows plans to be retroactively amended effective January 1, 2011 (or January 15, 2011, with regard
to debit card purchases), so long as the amendment is adopted no later than June 30, 2011.
Action for Compliance with OTC Rule
The new OTC Rule is not effective until January 1, 2011. However, plan sponsors and administrators should act now to ensure a
smooth transition including:
 Communicate the new OTC Rule to participants prior to 2011 enrollment (and possibly again in December) to ensure that participants take the new OTC Rule into consideration when making their new elections;  Confirm with TPAs and health debit card processors to ensure that OTC medicines and drugs will not be reimbursed starting January 1, 2011 (January 16 for health debit card purchases eligible for the transition rule), unless the prescription substantiation requirement is satisfied;  Implement new processes and procedures to ensure that every claim for an OTC medicine or drug has a valid Rx number or an accompanying prescription that satisfies all of the requirements of state law; and  Adopt plan amendments (prior to January 1, 2011, if possible) to implement the new OTC Rule.
As always, our consultants can assist you to review your plan and associated documents to determine applicability of the new
rules and confirm compliance.
For additional information contact:
Edwin R. Weeber, Jr., CEBS, CLU, ChFC 412.497.1757 This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified at orney, tax advisor or plan provider. This information has been taken from sources which we believe to be reliable, but there is no guarantee as to its accuracy. The information is intended solely for Gateway Financial Group clients. You may not display, reproduce, copy, modify, license, sell or disseminate in any manner any information included in this bulletin.

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