IRS Lead Counsel Memo 202317020 (March 29, 2023)
Available in https://www.irs.gov/pub/irs-wd/202317020.pdf
The IRS Office of General Counsel has released a memo that addresses the justification requirements for dependent care and medical expenses and the consequences of various justification shortcuts. The memo reconfirms that medical expense reimbursements from a Health FSA are included in an employee’s gross income if the Health FSA does not fully account for any expense by any employee in accordance with IRS rules (see our Point of control article). In addition, cafeteria plans that do not require an independent third party to fully account for all reimbursements for medical expenses (eg, by allowing employee self-certification or accounting for only some expenses (sampling) or not accounting for expenses below of a “de minimis” or “favored provider” dollar amount) or do not require verification of all DCAP reimbursement claims do not operate in accordance with those rules and will not qualify as cafeteria plans under the Code, resulting in in gross income for employees. The memo also reconfirms that reimbursements for dependent care expenses cannot be excluded from an employee’s gross income if such expenses for any employee are not accounted for after the expense is incurred.
The memorandum addresses six situations. In the first, a cafeteria plan uses traditional verification methods under your Health FSA, and only reimburses eligible medical expenses that are supported by information from an independent third party (i.e., an independent party of the employee and spouse and dependents of the employee) that describes the service or product, the date of the service or sale, and the amount of the expense. The plan also makes reimbursements using “EOB rollover” procedures that comply with IRS rules, requires employees to certify that expenses have not been reimbursed by insurance or otherwise, and that they will not seek reimbursement from any other plan. that covers health benefits, and provides a debit card program that complies with IRS rules. [EBIA Comment: It is interesting to note that the IRS has reiterated that the individual will not “seek reimbursement” from another plan rather than requiring that there be no other source of reimbursement.] In this situation, the memo explains, all claims are substantiated in accordance with the applicable Code and IRS requirements.
Four situations involve plans with different practices: allowing employee self-certifications (instead of independent third-party declarations); not require a statement from an independent third party for debit card charges that are not automatically verified; or using sampling, de minimis, or favored vendor approaches for debit card charges. According to the memo, because reimbursements are not limited to verified expenses, the plans do not meet applicable verification requirements and all reimbursements made during the year, including reimbursements for verified expenses, are included in the gross income of the employees. In the remaining situation, the plan automatically reimburses DCAP participants each pay period for a prorated portion of their certified annual dependent care expenses. Reimbursements are not limited to expenses incurred or verified, so the plan does not meet applicable verification requirements, and all payments made during the year are included in the employees’ gross income. The memo also notes that the cafeteria plans in these five situations do not work according to their written plans and cafeteria plan rules.
EBIA Comment: The IRS’s latest reminder about justification requirements for health FSAs and DCAPs doesn’t break any new ground: the rules have been in place for many years, and the ban on justification shortcuts is well known (for example, see our Checkpoint article and our Control Point question of the week). However, it serves as a useful review of the rules, while also highlighting potential problems with some current fixes and making it even more difficult for non-compliant plans to say they “didn’t get the memo.” We find it interesting that the memo is directed at the employment tax policy division, perhaps pointing the direction of audit activity. Employers and plan service providers may want to take this opportunity to verify their expense review and approval practices to ensure compliance with applicable rules. For more information, please refer to the EBIA Cafeteria Plans manual in sections XX.J (“Health FSA: Adequate substantiation of claims must be received from the participant and from an independent third party”), XXI.G (” Electronic Payment Card Programs for Health FSA”). , and XXIV.M (“DCAP: adequate justification of claims must be received”).
Contributing Editors: Thanks to attorney John R. Hickman for his contributions to this article, with final editing by EBIA staff. Mr. Hickman is a partner in Alston & Bird’s Employee Benefits Practice Group in Atlanta, www.alston.com, and is a contributing author of the EBIA manuals Cafeteria Plans, Consumer Driven Health Care, and Reform. of Health Care.