When debit cards were introduced for flexible spending accounts, many perceived this as a better way to facilitate medical expenses. Unfortunately, things have not always been so effortless, to the detriment of participants and the popularity of the card itself.

However, one expert has some fresh ideas about how the IRS can change the way they substantiate these claims in the hopes of drumming up more confidence around - and utilization of - FSA debit card transactions.

When the IRS first rolled out substantiation rules in 2007, requiring that all expenses from flexible spending accounts be substantiated by the cafeteria plan, these rules prohibited self-substantiation or self-certification of cafeteria plan claims.

Even though certain vendors - including pharmacies, physician offices and hospitals - use merchant codes to substantiate medical transactions, if certain requirements are not satisfied, participants may need to submit receipts.

For this reason, many participants find the process burdensome, despite the ease of using a debit card. According to Carl Mowery, managing director at LECG, a global expert services and consulting firm, utilization of FSA debit cards has slowed.

"We saw a substantial increase when the debit cards first came out," he explains - a 25% to 50% increase in some cases. "That's now flattened after all these new rules came into place and participants needed to send in all their receipts if the real-time substantiation rules are not met."

In fact, he continues, "many employees feel that the debit cards are not worth the hassle."

Conversely, reimbursements for medical expenses from health savings accounts can be self-substantiated.

Still, HSA participants must keep records to prove that the distributions were made to pay or reimburse qualified medical expenses, the qualified medical expenses were not previously paid or reimbursed from another source, and the medical expenses were not taken as an itemized deduction in any prior tax year.

"Five years ago, it was like, 'I must have a debit card for the FSA.' Now it's sort of a nonissue because the employees don't really appreciate it or don't want to deal with the hassles of it. So the IRS could in essence change the rules in order to provide some relief," suggests Mowery.

Is self-substantiation the solution?

Mowery has two suggestions concerning how the IRS could revive debit card use:

1. Create an upper limit where individuals don't need to have documents before reaching said limit. However, Leslye Laderman, a principal at Buck Consultants, is skeptical that this option would encourage the use of debit cards.

"If someone uses the electronic card, they have already received the reimbursement and all they are doing by submitting receipts is providing the required substantiation. So I'm not sure what is gained by delaying submission of receipts until they reach a specific amount, since the individual has already received the reimbursement," she argues. "If there is a delay in obtaining substantiation, it is more likely that someone might leave the company without having provided it."

Laderman goes on to explain that this suggestion would not satisfy requirements under the Section 125 proposed regulations which explicitly state that charges made using a debit card (other than substantiated copayments, recurring medical expense or real-time substantiation, or charges substantiated through the inventory information approval system) "must be substantiated, regardless of the amount of the payment."

2. Use self-substantiation (as for HSA and transportation debit cards) until audited by the IRS. Neal Devlin, director of operations at CBIZ Payroll, agrees that this proposal would make requirements easier but could create issues of compliance, as most participants do not understand the complexities of what is an approved expense in contrast to what is not.

Again, Laderman is more skeptical.

"The 125 rules with respect to the health FSAs and the HSA rules are under different sections of the Internal Revenue Code, and the rules are very different. I think it would be very difficult for them to use the same substantiation rules as under the HSA," she predicts.

Further, she says that employers can't control an HSA because it is not an employer-provided benefit and these accounts may reimburse nonmedical expenses. Also if a participant leaves the company, how would they substantiate their purchases? She concludes that this would be too ripe for abuse.

"Expenses reimbursed through a health FSA are treated as an employer-provided benefit - if the benefits aren't for medical expenses, they are included in the employee's income as compensation for services. Expenses reimbursed through an HSA are not treated as employer-provided and whether the expenses are included in income has nothing to do with the employer," she explains.

Mowery responds that he agrees "it would be difficult, but not impossible, as the IRS has taken creative approaches when there is desire to do something."

He also concedes that "there's probably no movement toward [changing the rules] at all, but there's not been that much of a public outcry."

Still, these changes may not be enough to spur FSA debit card growth. Other experts perceive other issues hampering their popularity, both now and in the near future.

Blaming health care reform

Amy Gordon, a partner at McDermott Will & Emery, believes that health care reform is slowing down the usage of and demand for FSA debit cards.

"The stagnation of growth might be due to the health care reform legislation's elimination of health flexible spending accounts use of over-the-counter reimbursement," she says. "As of 2013, it's going to cap health flexible spending accounts at $2,500. In addition, effective 2011, over-the-counter drugs cannot be reimbursed from an FSA without a prescription. That's a blow to health flexible spending accounts."

Devlin concurs: "[Growth of FSAs] has certainly slowed, and I believe that's the over-the-counter as well as the limit; people are already reacting to things that aren't in place yet."

Greater choices for participants may also be a factor, he adds.

"The HSA is much more open scope as far as what you can use the funds for without the need of substantiation. You can also use funds from an HSA for non-approved expenses - with a penalty," says Devlin.

Stagnation will continue

Further, this stagnation will only continue when health care reform caps out the FSA in 2013, which will mean a switch to HSAs, forecasts Devlin. Though he predicts that employees will still use the debit cards, they won't be using them for the FSA - they'll use the HSA instead.

"I think what you'll see for the next several years is an expansion of all [pretax savings account debit cards], but a faster growth rate will be in the HSAs," Devlin says. "It's just so much more convenient to use the money at your discretion and if you don't use it, you continue to save and it earns interest."

Someday, the FSA will be paperless with automatic substantiation, he expects. "In this day and age, it can only be a matter of time before the systems can be networked to identify at POS if an expense is valid or not.

--Kathleen Koster

This story originally ran on Employee Benefit News, a sister publication of Health Data Management.


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