IRS Gives a Little, Takes a Little in Latest Debit Card Guidance

In July 2006, the IRS issued what one might call a homework assignment to major merchants and FSA/HRA electronic payment card/debit card vendors. The assignment was easily understood but not easily accomplished: create an Inventory Information Approval System (IIAS) before 2007 to allow debit card use and auto-substantiation at merchants with non-health care related merchant category codes (MCCs).

In December 2006, the IRS gave a one-year extension on the homework assignment. In Notice 2007-02, the IRS provided temporary relief from the January 1, 2007, deadline. However, in the same notice, the IRS issued a second homework assignment: by January 1, 2009, all merchants with MCCs of Drug Stores and Pharmacies must have a similar IIAS in place.

To better understand the current state of debit card rules, it is best to view existing guidance in terms of pre-work assignment and homework assignment:

1. Pre-Work Assignment: Original Debit Card Guidance (Notice 2003-43)

Issued in 2003, Notice 2003-43 established the original debit card rules. Among them was the rule that debit card use was “limited to physicians, pharmacies, dentists, vision care offices, hospitals, and other medical care providers.” Transactions required paper substantiation unless they fell into three auto-substantiation categories: copayment matching, recurring expenses and real-time verification.

2. Homework Assignment No. 1: IIAS for Non-Health Care Related MCCs (Notices 2006-69 & 2007-02)

Fast forward three years to mid-2006. Notice 2006-69 broadened Notice 2003-43’s limitation described above, permitting debit card use at non-health care related merchants if they implemented an IIAS by January 1, 2007. At the point of sale, the IIAS would review each expense item, determine if it was eligible for FSA/HRA reimbursement and pay for eligible items only. Participants would pay for non-eligible items via other means, like cash, check or another credit card. No follow-up substantiation would be required.

News of the IIAS met with mixed reviews. On one hand, it provided a clear solution to troublesome pay-and-chase paper substantiation procedures. On the other hand, establishing a uniform IIAS covering all eligible items has proven a daunting task.

Last fall, a contingent of interested parties pleaded their case with the IRS, asking for an extension of the deadline. In Notice 2007-02, the IRS granted this wish. Thus, through December 31, 2007, all non-health care related MCC merchants will be deemed to be “other medical care providers” as originally described in Notice 2003-43. Employers must continue to substantiate all expenses in accordance with previous guidance.

3. Homework Assignment No. 2: IIAS for Drug Stores and Pharmacies (Notice 2007-02)

The IRS also observed that pharmacies and drug stores – which currently have health-related MCCs – sell a significant number of items that do not qualify for FSA or HRA reimbursement. Therefore, after December 31, 2008, FSA and HRA debits cards cannot be used at a store with the Drug Stores and Pharmacies MCC unless the store meets one of these requirements:

• The store participates in the IIAS described in Notice 2006-69.
• On a location-by-location basis, 90% of the store’s gross receipts during the prior taxable year consisted of items that would be reimbursable under an FSA or HRA, including over-the-counter medications.

While this is an additional requirement beyond what was in Notice 2006-69, the IRS has given drug stores and pharmacies more than two years in which to comply.

Infinisource continues to work with our debit card and other related vendors to ensure compliance with these rules. As a reminder, we offer comprehensive FSA/HRA administration services that can include a debit card. Simply contact our Sales Department at 800-779-6384 if you are interested in this service.

A copy of Notice 2007-02 is available at www.irs.gov/pub/irs-drop/n-07-02.pdf.

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