Possibly because there has been more than a little bit of misinformation sent around, the Internal Revenue Service issued guidance reflecting statutory changes regarding the use of certain tax-favored arrangements, such as flexible spending arrangements (FSAs), to pay for over-the-counter medicines and drugs.  The guidance also addresses other misunderstood aspects about the new legislation.

The Affordable Care Act, enacted in March, established a new uniform standard that will be effective January 1, 2011.   It applies to FSAs and Health Reimbursement Arrangements (HRAs). Under the new standard, the cost of an over-the-counter medicine or drug cannot be reimbursed from the account unless a prescription is obtained.

The change does not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles. The new standard applies only to purchases made on or after January 1, 2011.  Claims for medicines or drugs purchased without a prescription in 2010 can still be reimbursed in 2011, if allowed by the employer’s plan.

A similar rule goes into effect on January 1, 2011 for Health Savings Accounts (HSAs), and Archer Medical Savings Accounts (Archer MSAs).

Employers and employees should take these changes into account as they make health benefit decisions for 2011. The new small business health care tax credit is effective now as part of the Affordable Care Act, which became law this year.

Who’s eligible for the credit?

The credit is targeted to help employers with low and moderate income workers afford to offer employees health insurance coverage. Generally, employers that have fewer than 25 full-time equivalent (FTE) employees and pay wages averaging less than $50,000 per employee per year may qualify for the credit. Because the eligibility formula is based in part on the number of FTEs, not the number of employees, employers that have more than 25 individual workers may also qualify if some of their workers are part-time.

Another bit of misunderstood information

The changes include the information about employers having to report on employees’ Form W-2 the cost they pay for employee health insurance.  Starting in tax year 2011, the Affordable Care Act requires employers to report the value of the health insurance coverage they provide employees on each employee's annual Form W-2.  This reporting is for informational purposes only, to show employees the value of their health care benefits so they can be more informed consumers.

Section 106 of the act specifically provides that the gross income of an employee does not include employer-provided coverage under an accident or health plan. This appears to be one of the major pieces of mis-information that has been circulating, largely through emails. The amount reported does not affect tax liability, as the value of the employer contribution to health coverage continues to be excludible from an employee's income and it is not taxable.

For details on current rules, see Publication 969 , Health Savings Accounts and Other Tax-Favored Health Plans. Updates on this and other health care reform provisions can be found on the Affordable Care Act page on IRS.gov. An interesting brochure which clarifies some of these items can be found here.

Many other changes can dramatically affect family health coverage.  For example, Health coverage for an employee's children under 27 years of age is now generally tax-free to the employee.

For more information or assistance, please contact your local PRO-TAX office by calling 1-800-809-2829.