Q&A: Participants: Eligible Expenses

Expenses for capital expenditures are seldom eligible for Medical FSA reimbursement. The reason is that flexible spending accounts are subject to regulations preventing the deferral of compensation, defined to include "the use of contributions from one plan year to purchase a benefit that will be provided in a subsequent plan year." (Hence, the "Use it or Lose it" rule.) Thus, reimbursement of capital items having a useful life extending beyond the taxable year is prohibited. However, under Treas. Reg. 1.213(e)(l)(iii), a capital expenditure related directly to medical care may qualify as a reimburseable expense even though it results in a permanent improvement to property to the extent that the expenditure exceeds the increase in the value of the related property.

As an example, some of the allergy-related expenses that can be reimbursed by a Medical FSA if doctor-prescribed to treat a specific medical condition may include:

• Air Conditioner - If primarily used by the sick person to treat a medical condition and detachable from the property. If attached to the property, only the amount spent that is more than the value added to the property can be reimbursed.
• Air Purifier - If prescribed by a doctor to treat a specific medical condition such as a severe allergy.
• Allergy Treatment Products and household improvements to treat allergies: filters, pillows, special vacuums, etc. - Not if the product is one which would be owned even without allergies, such as a pillow or a vacuum. However, an air purifier or water filter necessary to treat a specific medical condition may be allowable.

Eligibility of other, more "big-ticket" items proves more challenging:

• Does the cost of the capital expenditure span multiple plan years?  (Issue: When is the expense "incurred"??)
• Are the benefits of the capital expense realized over multiple years? Almost always, the answer is "yes".  (Issue: Does this violate the rule against deferral of compensation?)
• As a result, our tax counsel suggests that we limit reimbursement to the amount allocable to the particular plan year, and:
  • Require a physician's prescription and substantiation of the medical necessity and specific medical condition to be treated; and
  • If the capital expenditure is for a "permanent" improvement, require a third-party appraisal to substantiate the "excess" cost that may be deductible.

In summary, our role as plan service provider is to provide informed counsel on compliance with applicable regulations on flexible benefit plans.

The ultimate defense of eligibility of an item for Medical FSA reimbursement may come in an IRS audit of an individual tax return. The examiner may require substantiation of the exclusion of Medical FSA benefits from taxation. Substantiation of each item reimbursed (excluded from income) may be required, and must be found adequate.

Clearly, in the case of capital items, the amounts are material and one must be prepared to fully substantiate eligibility for Medical FSA reimbursement. It behooves the participant to seek his own tax counsel's expert opinion prior to seeking reimbursement for these significant expenses.