Health FSAs — Why are Some Expenses Not Reimbursable?
When it comes to offering a Flexible Spending Account (FSA), employers do not usually have the capabilities or the time to manage all aspects of the plan, so it makes sense to contract with a third-party administrator (TPA) to carry out administrative functions, particularly the time-consuming task of claims processing.
So, what explanation can an employer provide when an employee complains that the TPA has denied their FSA claim?
Most FSA claim reimbursements are paid without any issue. If the participant uses their benefit card to pay for an eligible expense, that makes things even easier. But some claims may require the employee to complete paperwork and submit evidence that documents the expense is eligible for reimbursement.
Claims may be denied for a variety of reasons, including that the claim was not submitted timely, or the claim lacks appropriate documentation. One reason for denied claims that can be controversial is that the claim was not for medical expenses – meaning that the item or service does not meet the IRS’s requirements to be considered an eligible medical expense.
To determine if an expense is for medical reasons, the IRS looks to the definition of medical care, as found in the Internal Revenue Code, section 213(d)(1)(A), where it is defined as “for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body.” This definition leaves much to interpretation, and additional clarifying guidance from the IRS has been limited.
Some services and items clearly meet this definition. The IRS has specified that if an item has no purpose other than to treat a disease it will qualify as medical care. For example, if someone is diagnosed with strep throat and they get a prescription for penicillin, the expense would be for medical care and is FSA-eligible since the prescription is for the treatment of a disease and there is no other benefit that the penicillin can offer.
On the other end of the spectrum are expenses that the IRS has classified as “personal expenses” that are only beneficial to general health. These types of expenses are not considered medical expenses, as their primary purposes is not to alleviate or prevent illness. A good example of this is vitamins, which don’t treat any type of illness, but taking them may make someone healthier overall.
Other items are much less clear and occupy a grey area between medical and personal. Sunscreen is an item that frequently makes this list. It is beneficial to general health because it prevents sunburns. However, there is evidence to indicate that using sunscreen regularly decreases your chances of developing skin cancer, so could sunscreen be used to prevent disease? The IRS has (informally) stated that sunscreen “might be” a medical expense. Their reluctance to officially declare sunscreen a medical expense may be the result of other guidance they have produced that states an item can only be for the prevention of disease, if a disease already exists, or if there is an imminent probability of developing a disease. In the case of skin cancer, it is often something that manifests after many years of sun exposure and is not tied to one particular exposure to UV light.
To further complicate matters, some expenses that the IRS usually considers personal can be classified as a medical expense if the taxpayer uses the item to treat a disease or an injury. A good example of this is a gym membership, which can be beneficial to general health and therefore it is a personal expense. But if the membership was purchased for the sole purpose of treating a disease, such as obesity, it would be considered a medical expense. Generally, when expenses like this can be either personal or medical a TPA will require the individual to submit evidence from their physician, like a letter of medical necessity, that reflects why a particular treatment has been recommended.
Without definitive guidance on certain expenses that occupy that grey area between personal and medical, it is up to the plan administrator—often a TPA—to set standards for processing claims based on the available guidance. When clear guidance is not available, they may search for answers in ancillary sources of guidance (like FDA publications), request opinions from legal advisors, or rely on positions taken by others in the industry. Not all TPAs will have the same policies, and some may be more cautious when setting their reimbursement parameters.
Ultimately, a TPA that is processing FSA claims will be doing so objectively and not exercising discretion in the process. The employer, acting as the plan administrator, may have to make discretionary decisions on claims from time to time, if there is no guidance that the TPA can rely on to make a reasoned determination. When it is necessary for the plan administrator to make the final call, the TPA will provide as much information as possible to help the plan administrator make informed choices to ensure the plan maintains compliance with legal and regulatory requirements.
The stakes are high if proper scrutiny is not applied to processing reimbursements. If, for example, FSA reimbursements are made for expenses that are not medical, then the expense is not eligible for reimbursement from the plan, and the tax-qualified status of the entire plan (not just the amount of the one reimbursement) is in jeopardy.
For employers, understanding that claims for expenses can lie in grey areas and exercising a bit of caution in favor of the plan ensures the greatest overall benefit to participants.
