How Clients Can Spend Health Savings Dollars Wisely

As we move deeper into the fourth quarter, many individuals may be starting to focus on spending down dollars in their tax-preferred health savings accounts (HSAs), health flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs). Some of these valuable accounts are subject to a “use-it-or-lose-it” rule where funds not spent before the end of the year (and any applicable grace period) are simply forfeited.

Individuals who have funded these types of accounts should be reminded about the changed rules governing the purchase of over-the-counter items with these accounts. Clients should ensure their purchases satisfy IRS requirements before making purchases such as personal care items and items other than actual medicines.

Reimbursing Over-the-Counter Medical Costs: The Basics

As most clients realize, amounts withdrawn from accounts like HSAs, HRAs and FSAs are tax-free if they’re used to pay for qualified medical expenses. Generally speaking, the law defines qualified medical expenses as those paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting a structure or function of the body.

Prior to 2020, over-the-counter medicines only qualified as “qualified medical expenses” if they were prescribed by a doctor. The 2020 CARES Act removed the prescription requirement for over-the-counter drugs. Payments for drugs and medicines are always qualifying expenses, even without a prescription. That includes medicines such as cold and flu medications, headache treatment, etc.

It’s also possible that other types of expenses can qualify as medical expenses. The question is whether the costs are incurred primarily for preventing or alleviating a physical or mental condition. It’s also possible that the specific plan could limit the types of items that can qualify for tax-free treatment.

The Test for Determining Qualifying Status

Costs for certain non-medicine items are only qualified medical expenses if the costs would not have been incurred “but for” the need to treat a physical or mental condition. If the taxpayer would have purchased the item regardless of any medical condition, it does not qualify as a medical expense for HRA, HSA and FSA purposes.

Items that are purchased to support general health and well-being do not qualify as medical expenses for tax purposes. It’s primarily the taxpayer’s motive in making the purchase that will dictate tax qualification. Items are more likely to be treated as legitimate medical expenses if they have been recommended by a doctor for treating an identified medical condition.