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IRS Guidelines: Tax-Advantaged Accounts Limited To Medical Expenses For Employers

Tax-advantaged accounts or reimbursement plans for healthcare are a popular benefit offered by employers. They are great because they help organizations handle high medical costs, while giving employees a tax-friendly way to manage medical expenses.

The IRS, however, has concerns. The tax agency recently issued a news release (IR-2024-65) warning plan administrators that only qualified medical expenses are eligible for deductions or reimbursements under these accounts or arrangements. Personal expenses for “general health and wellness” aren’t.

Four Common Vehicles

The IRS news release specifically addresses four commonly used vehicles for helping employees manage medical expenses:

  1. Health Flexible Spending Accounts (FSAs). Participants can channel up to $3,200 in 2024 (up from $3,050 in 2023) of pretax income into these standalone, employer-owned accounts. The account then reimburses the participant for qualified medical expenses.
  2. Health Savings Accounts (HSAs). These participant-owned accounts must be offered in conjunction with a high-deductible health plan. In 2024, participants can contribute pretax income of up to $4,150 for self-only coverage (up from $3,850 in 2023) and $8,300 for family coverage (up from $7,750 in 2023).
  3. Health Reimbursement Arrangements (HRAs). Rather than being individual participant accounts, HRAs are employer-sponsored plans that reimburse participants for eligible medical expenses. There are several different versions. Generally, employers may claim a tax deduction for reimbursements, which are typically tax-free for participants.
  4. Medical Savings Accounts (MSAs). These participant-owned accounts, sometimes referred to as “Archer MSAs,” are a precursor to HSAs intended for self-employed people and very small organizations. Congress discontinued the creation of new MSAs in 2007, but some employers still sponsor accounts created before then.

 

Aggressive Marketing 

The IRS’s concerns spring largely from what it calls “aggressive marketing.” That is, according to the news release, “… some organizations are misrepresenting circumstances under which food and wellness expenses can be paid or reimbursed under FSAs and other health spending plans.”

The tax agency says certain organizations are telling customers that, if they can get a doctor’s note supporting purchases of nonmedical food, wellness, or exercise products or services, the associated costs can be converted to tax-qualified medical expenses. But this generally isn’t true. The news release even includes an example in which an organization offers to provide a doctor’s note to a customer, for a fee, that would allow the individual to claim an FSA reimbursement for low-carb food products targeted at people with diabetes.

Under Internal Revenue Code Section 213, qualifying medical expenses are defined as amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting a structure or function of the body. They don’t include expenses related to products or services that are merely beneficial to health and wellness.

Friendly Reminder

If your organization sponsors one of the accounts or arrangements mentioned above, you may want to pass along the IRS’s friendly reminder to participants. The tax agency warns in the news release that if a health FSA, HSA, HRA or MSA is used to pay or reimburse nonmedical expenses, all payments from the account or arrangement — including valid reimbursements — may be includible in the participant’s income. Contact us for more information.

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