Guidance from the IRS
Guidance from the IRS
The Treasury Department and the Internal Revenue Service (IRS) recently issued guidance that upholds the tax-favored status of unused balances in employer-funded health care reimbursement arrangements, often referred to as "Medical Savings Accounts" (MSAs), that provide for employee-controlled reimbursement of medical costs. "With this new guidance, we clear the way for employers to adopt health plans with Patient-directed features so that employees have more choice and greater control over their health care coverage," stated Treasury Secretary Paul O'Neill.
The IRS guidance provides that medical benefits paid by an MSA are not taxable. To qualify for the exclusions from gross income under sections 106 and 105 of the Internal Revenue Code, an MSA may only provide benefits that reimburse substantiated medical care expenses as defined in section 213(d) of the IRC and must be funded solely by the employer, among other requirements. In addition, the guidance clarifies that MSAs generally are not subject to the complex design requirements for health Flexible Spending Arrangements (FSAs) that are funded through salary reductions under an IRC Section 125 (cafeteria) plan.
The IRS provided two fact situations to illustrate the exclusion for MSA reimbursements. In one scenario, unused MSA amounts that remain when an employee retires or terminates employment are returned to the employer. In the other, unused amounts remain available following retirement, but the maximum reimbursement is not increased. Under both scenarios, the employer pays for the MSA and the employee has no right to receive cash or any benefit other than reimbursement for eligible medical care expenses under the MSA.
The guidance exempts MSAs from the Section 125 cafeteria plan rules as long as no part of the employees’ cafeteria plan salary reductions funds the MSA. The salary reductions may pay for the managed care health plan offered in conjunction with the MSA. To be exempt from Section 125 rules, salary reductions used to pay for the health plan must not be greater than the COBRA-applicable premium. Also, if more than one health plan option is available in conjunction with an MSA or if there is a choice of MSA reimbursement amounts, salary reductions to pay for the health plan may not be correlated to the reimbursement amount under the MSA.
The guidance specifically clarifies that:
Ø Unused amounts in an MSA may be carried over to subsequent years (i.e., the "use it or lose it rule" governing FSAs does not apply to MSAs); and
Ø MSAs may be used to reimburse employees for the purchase of health insurance.
In addition, the guidance provides that MSA reimbursement arrangements:
Ø May allow former employees, including retirees, continued access to unused reimbursements;
Ø Coordinate with an FSA funded by salary reduction; and
Ø Are group health plans subject to the COBRA continuation requirements.
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