IRS Issues Memorandum Addressing Medical Expense Substantiation

The Internal Revenue Service (IRS) recently released a memorandum from the Office of the Chief Counsel addressing claims substantiation for payment or reimbursement of medical and dependent care expenses. While this type of guidance cannot be relied upon by taxpayers, it does provide insight and direction for revenue agents regarding a position that the IRS has taken on a particular issue and how cases may be evaluated under audit.

The memorandum provides guidance on claims substantiation for medical expenses from a health flexible spending account (FSA) and dependent care expenses from a dependent care assistance program (DCAP). It sets out various situations and provides guidance on whether the practice complies with the requirements under the proposed regulations and if reimbursements from the plan are permitted to be exempt from gross income of the employees. 

The memorandum leads off with an arrangement that is specified to be compliant, resulting in the amounts that are reimbursed from the plan as excludable from an employee’s wages.

  • An FSA permits reimbursements for medical expenses that have been substantiated by (1) an independent third party with information describing the service or product, the date of the service or sale and the amount of the expense, or (2) information from a third party that is an “explanation of benefits” from an insurance company or similar document, or (3) use of a debit card that meets the requirements of the proposed regulations.

The following scenarios reimburse expenses as described above, but also have alternative substantiation methods applied. As a result, each of these scenarios would not comply with the requirements of the proposed regulations and all amounts paid under the arrangement would be includable in the gross income of employees.

  • An FSA permits employees to self-certify expenses and does not substantiate debit card expenses with information from an independent third party.
  • An FSA permits reimbursement of all debit card charges and only requires a random sample of charges to be substantiated. 
  • An FSA permits reimbursement of all debit card charges that are below a specified dollar amount.
  • A plan does not require substantiation of debit card charges from certain dentists, doctors, hospitals or other health care providers.

The memorandum also contemplates substantiation of expenses from DCAP plans and provides the following noncompliant scenario whereby the requirements of IRC 129 and 125 are not met and all amounts paid would be includable in the gross income of employees.

  • For dependent care expenses, a plan permits employees to submit in advance for dependent care expenses and they are automatically reimbursed a pro-rata amount every pay period.