What types of expenses can an employee be reimbursed for under a health care FSA?

Editor's Note: On March 26, 2021, the Internal Revenue Service issued Announcement 2021-7 PDF clarifying that the purchase of personal protective equipment, such as masks, hand sanitizer and sanitizing wipes, for the primary purpose of preventing the spread of coronavirus are deductible medical expenses. This is effective from January 1, 2020 through December 31, 2022.

The amounts paid for personal protective equipment are also eligible to be paid or reimbursed under health flexible spending arrangements (health FSAs), Archer medical savings accounts (Archer MSAs), health reimbursement arrangements (HRAs), or health savings accounts (HSAs).

Reimbursable  expenses under a health care flexible spending account (FSA) include medical expenses for an employee, the employee's spouse and the employee's dependent children that are primarily for a medical purpose and not covered by insurance or another plan. Eligible expenses must fall within the legal definition of medical care as defined in Internal Revenue Code (IRC) §213(d), although an employer's plan document will ultimately determine what expenses are reimbursable under the employer's FSA plan. Typical items eligible for reimbursement include co-insurance payments, deductible payments, eyeglasses, hearing devices, prescription drugs, psychiatric care and emergency ambulance service.

The Coronavirus Aid, Relief and Economic Security Act, passed in late March 2020, permanently reinstates over-the-counter medical products as eligible expenses for HSAs, certain HRAs and FSAs without a prescription. This rolls back rules from the Affordable Care Act which required a prescription for eligible medical expenses. Additionally, these accounts may now allow certain menstrual care products, such as tampons, pads, liners and cups as eligible medical expenses. These are permanent changes and apply retroactively to purchases beginning Jan. 1, 2020.

To be considered "primarily for a medical purpose," an expense must be needed to treat or alleviate a specific physical or mental illness. Employers should consider the following:

• Expenses that simply benefit an individual's health, such as a vacation, are not eligible for reimbursement unless a physician has indicated that the expense is necessary to treat or relieve a specific physical or mental illness.
• The "but for" test: Is the expense a personal expense that would have been incurred regardless of the medical condition? For example, courts have found that ballet lessons that alleviated a child's scoliosis were not eligible for reimbursement since the child was enrolled in the lessons prior to being diagnosed.
• Individuals are expected to consider lower-cost alternatives to medical expenses and avoid unreasonably expensive or lavish options, although there is no requirement that an individual choose the lowest-cost option. If an individual opts for an extravagant expense when other options are available, the excess expense may not be eligible for reimbursement.

Examples of items that are excluded from reimbursement by code or regulation include:

• Cosmetic procedures (except to cure a deformity, congenital abnormality, etc.).
• Illegal operations or treatments.
• Qualified long-term care services.
• Insurance premiums.

Because there are differences between expenses that an employee may deduct from his or her individual income tax and expenses that an employer can reimburse through an FSA, employers are discouraged from relying on IRS Publication 502 when administering an FSA plan. Rather, IRC §105(b) and §213 provide guidance specific to health FSA reimbursements.