n-06-69.pdf

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Part III — Administrative, Procedural, and Miscellaneous

Section 105 - Amounts Received Under Accident and Health Plans
Section 129 – Dependent Care Assistance Programs (Also Section 106-
Contributions by Employers to Accident and Health Plans and Section 125-
Cafeteria Plans)

Debit cards used to reimburse participants in self-insured medical reimbursement
plans and dependent care assistance programs.

Notice 2006-69

I. PURPOSE

This notice provides further guidance on the use of debit cards, credit
cards, and stored value cards (cards) to reimburse participants in self-insured
medical reimbursement plans, such as health flexible spending arrangements
(health FSAs) and health reimbursement arrangements (HRAs). See Rev. Rul.
2003-43, 2003-1 C.B. 935. This notice also clarifies certain substantiation
methods and requirements that apply to all medical reimbursement plans
whether or not a card is used. Finally, the notice provides guidance on the use of
cards to reimburse participants in dependent care assistance programs (DCAPs),
including dependent care flexible spending arrangements (dependent care
FSAs).
II. BACKGROUND:
Rev. Rul 2003-43 addresses the use of cards to reimburse participants in
health FSAs and HRAs. The ruling describes three situations in which employers
adopt electronic reimbursement systems in connection with health FSAs and

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HRAs. In each of the three situations, employees who participate in the health
FSA or HRA are issued cards.
Each participating employee certifies upon enrollment and for each plan
year thereafter that the card will only be used for eligible medical care expenses
of the employee, the employee’s spouse and dependents. The employee also
certifies that any expense paid with the card has not been reimbursed and that
the employees will not seek reimbursement under any other plan covering health
benefits. The certification is printed on the back of the card and the employee-
cardholder understands the certification is reaffirmed each time the card is used.
The use of the card is limited to the maximum dollar amount of coverage
available in the employee’s health FSA or HRA. The card can only be used at
merchants and service providers that have merchant category codes related to
health care, such as physicians, pharmacies, dentists, vision care offices,
hospitals, and other medical care providers.
In Situation 1 of the ruling, the employer establishes the following
procedures for substantiating claimed medical expenses after the card is used.
First, if the dollar amount of the transaction at a health care provider equals the
dollar amount of the copayment for that service under the accident or health plan
(i.e., the major medical plan, health maintenance organization, etc.) covering the
specific employee-cardholder, the charge is fully substantiated without the need
for submission of a receipt or further review (i.e., copayment match). Second,
the employer permits automatic reimbursement without further review of
recurring expenses that match expenses previously approved as to amount,

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provider, and time period (i.e., recurring expenses). Third, if the merchant,
service-provider, or other independent third-party (e.g., Pharmacy Benefit
Manager), at the time and point-of-sale, provides information to verify to the
employer (including electronically by e-mail, the internet, intranet, or telephone)
that the charge is for a medical expense, the charge is fully substantiated without
the need for submission of a receipt or further review (i.e., real-time
substantiation).
All other charges to the card are treated as conditional pending
confirmation of the charge by the submission of additional third-party information,
such as a receipt. Claims that are identified as not qualifying for reimbursement
because of lack of additional information or otherwise, are subject to certain
correction procedures.
Rev. Rul. 2003-43 concludes that the procedures adopted by the
employer in Situation 1 meet the requirements of § 105(b) because all claims for
medical expenses are substantiated, either automatically or by the submission of
additional information. Card systems that do not meet the requirements of
§ 105(b) result in all payments provided by the cards being included in the
participant’s income.
III. ADDITIONAL USE OF CARDS TO SUBSTANTIATE HEALTH FSA AND
HRA MEDICAL EXPENSES

In addition to the substantiation methods approved in Rev. Rul. 2003-43,
as described below, an employer may adopt additional methods for
substantiating claimed medical expenses. Employers that adopt these methods
must also comply with requirements of Treas. Reg. § 1.105-2, Prop. Treas. Reg.

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§ 1.125-2, Q & A-7, Notice 2002-45, 2002-2 C.B. 93, and Rev. Rul. 2003-43,
including, but not limited to, employee certifications and adoption of meaningful
correction procedures for amounts that are not automatically substantiated at the
point-of-sale or within a reasonable time after the transaction.
A. Copayment Amounts

As described in Rev. Rul. 2003-43, the copayment match substantiation
method is only permissible at merchants or service-providers that have health
care related merchant category codes. Consistent with this approach, this notice
expands the copayment match substantiation method to include as automatic
substantiations certain matches of multiple copayments. Under this method, if
the employer’s accident or health plan has copayments in specific dollar
amounts, and the dollar amount of the transaction at a health care provider (as
identified by its merchant category code) equals an exact multiple of not more
than five times the dollar amount of the copayment for the specific service (i.e.,
pharmacy benefit copayment, copayment for a physician’s office visit, etc.) under
the accident or health plan (i.e., the major medical plan, health maintenance
organization, etc.) covering the specific employee-cardholder, then the charge is
fully substantiated without the need for submission of a receipt or further review.
In addition, if a health plan has multiple copayments for the same benefit, (e.g.,
tiered copayments for a pharmacy benefit), exact matches of multiples or
combinations of the copayments (but not more than the exact multiple of five
times the maximum copayment) will similarly be fully substantiated without the
need for submission of a receipt or further review.

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If the dollar amount of the transaction at a health care provider exceeds a
multiple of five or more times the dollar amount of the copayment for the specific
service, the transaction must be treated as conditional pending confirmation of
the charge by the submission of additional third-party information. In the case of
a plan with multiple copayments for the same benefit, if the dollar amount of the
transaction exceeds five or more times the maximum copayment for the benefit,
the transaction must also be treated as conditional pending confirmation of the
charge by the submission of additional third-party information. Similarly, if the
dollar amount of the transaction is not an exact multiple of the copayment (or an
exact match of a multiple or combination of different copayments for a benefit in
the case of multiple copayments for the same benefit), the transaction must be
treated as conditional pending confirmation of the charge, even if the amount is
less than five times the copayment. In these cases, the employer must require
that additional third-party information, such as merchant or service provider
receipts, describing (1) the service or product, (2) the date of the service or sale
and, (3) the amount, be submitted for review and substantiation.
The copayment schedule required under the accident or health plan must
be independently verified by the employer (i.e., the copayment amount must be
substantiated by a third-party; statements or other representations by the
employee are not sufficient).
Example 1
. Employer W reimburses health FSA claims through debit
cards, as described in Situation 1 of Rev. Rul. 2003-43. Employee A and
Employee B are participants in the health FSA and are enrolled in W’s medical

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plan. The plan has a $5 copayment for generic prescriptions and a $10
copayment for all other prescriptions.
A uses the card at a pharmacy to purchase five non-generic prescriptions,
for a total card transaction of $50. W’s system matches the amount of the
transaction, $50, with the $10 copayment for non-generic prescriptions under A's
coverage and the fact that the transaction is at a pharmacy. Because the
amount of the transaction is an exact multiple not in excess of five times the
maximum copayment for prescriptions under A’s medical coverage and the
transaction is at a pharmacy, the transaction is substantiated without further
review or documentation.
B uses the card at a pharmacy to purchase three generic prescriptions
and three non-generic prescriptions for a total card transaction of $45. Because
the transaction is at a pharmacy and the amount of the transaction is an exact
match of a combination of the copayments and does not exceed fives times the
maximum copayment for prescriptions under B’s medical coverage, the
transaction is substantiated without further review or documentation
Example 2
. The facts are the same as Example 1 except that A uses the
card at a pharmacy to purchase six non-generic prescriptions for a total charge of
$60. Because the amount of the transaction exceeds five times the maximum
copayment for prescriptions under A’s medical coverage, the entire
transaction must be further substantiated through the submission of a receipt
indicating that A purchased prescription drugs, the date of the purchase, and the
amount of the purchase.

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Example 3. The facts are the same as Example 1, except that A uses the
card at a pharmacy to purchase two non-generic prescriptions and a
nonprescription medication. The amount of the transaction is $27. Because the
amount of the transaction is not an exact match of a multiple or combination of
the copayments for generic and non-generic prescriptions under A’s medical
coverage, the transaction must be further substantiated through the submission
of a receipt indicating that A incurred a medical expense (the prescription drugs
and nonprescription medication), the date of the purchase and the amount of the
purchase.
B. Inventory Information Approval System

An employer may adopt the method described below for approving
reimbursements made through a payment card in conjunction with a health FSA
or an HRA. Under this method, the payment card processor provides a system
for approving and rejecting card transactions using inventory control information
(e.g., stock keeping units (SKUs)) with merchants who need not be health care
providers as described in Rev. Rul. 2003-43. Card transactions using this
method are fully substantiated without the need for submission of a receipt by the
employee or further review.
Under this method, when an employee uses the card, the merchant’s
system collects information about the items purchased using the inventory
control information (e.g., SKUs). The system compares the inventory control
information for the items purchased against a list of items, the purchase of which
qualifies as expenses for medical care under § 213(d) (including nonprescription

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medications as described in Rev. Rul. 2003-102, 2003-2 C.B. 559). The § 213(d)
medical expenses are totaled and the merchant’s or payment card processor’s
system approves the use of the card only for the amount of the §213(d) medical
expenses subject to coverage under the health FSA (taking into consideration
the uniform coverage rule) or HRA. If the transaction is only partially approved,
the employee is required to tender additional amounts, resulting in a split-tender
transaction.
As described in Rev. Rul. 2003-43, if the merchant, service provider, or
other independent third-party at the time and point-of-sale provides information to
verify to the employer (including electronically by e-mail, the internet, intranet, or
telephone) that the charge is for a medical expense, the charge is fully
substantiated, without the need for submission of a receipt for further review (i.e.,
real-time substantiation). Similarly, the inventory information approval system
satisfies the substantiation requirements for purposes of reimbursing an
employee’s § 213(d) medical expenses without further review. However, an
employer that adopts this system is nonetheless responsible for complying with
all requirements in this notice, including recordkeeping requirements. Under this
notice, the information required to be retained may be provided at the time of the
transaction, or after the transaction (e.g., upon an examination of the employer
by Internal Revenue Service). Rev. Proc. 98-25, 1998-1 C.B. 689, which sets out
requirements where a taxpayer’s records are maintained within an automatic
data processing system, also applies to the inventory information approval
system.

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An employer using this system may expand card use to merchants or
service-providers that do not have health care related merchant category codes,
provided that the only non-health care related merchants or service-providers
where the card can be used are those that use the system (i.e., participating
merchants or participating service-providers). Under the inventory information
approval system, attempts to use the card at non-participating merchants or
service-providers would be rejected.
For example, if, after matching inventory information, it is determined that
all items purchased are § 213(d) medical expenses, the entire transaction is
approved, subject to the coverage limitations of the health FSA or HRA. If, after
matching inventory information, it is determined that only some of the items
purchased are § 213(d) medical expenses, the transaction is approved only as to
the § 213(d) medical expenses. In this case, the merchant or service-provider
would request additional payments from the employee for the items that do not
satisfy the definition of medical care under § 213(d). The merchant or service-
provider would also request additional payments from the employee if the
employee does not have sufficient health FSA or HRA coverage to purchase the
§ 213(d) medical items.
Example
. Employer Y reimburses health FSA claims through debit cards,
as described in Situation 1 of Rev. Rul. 2003-43. Y has adopted the inventory
information approval system. Several stores that do not have health care related
merchant category codes participate in the system (i.e., participating merchants).
These participating merchants sell nonprescription medications. The use of the

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card has been expanded to include the participating merchants.
Employee C is a participant in the health FSA sponsored by Employer Y
and has $100 of health FSA coverage. Y’s health FSA covers nonprescription
medications. C purchases aspirin, antacid, and cold medication for C and C’s
spouse and dependents at one of the participating merchants. The total amount
for these medical expenses is $20.75. At the same time, C also purchases
$50.00 of items that do not qualify as medical expenses under § 213(d), for a
total purchase amount of $70.75. The store’s system compares the SKUs from
all of the items against the SKUs from a list of items that qualify as medical
expenses under § 213(d). The charge for the medical expenses totaling $20.75
is authorized and the remaining $50.00 is rejected. Employee C is asked for
additional payment to purchase the remaining non-medical items.
IV. OTHER SUBSTANTIATION ISSUES
A. Direct Third-Party Substantiation

If the employer is provided with information from an independent third-
party (such as an explanation of benefits from an insurance company (EOB))
indicating the date of the § 213(d) service and the employee’s responsibility for
payment for that service (i.e., coinsurance payments and amounts below the
plan’s deductible), the claim is fully substantiated without the need for submission
of a receipt by the employee or further review.
Example
. Employee D is a participant in the health FSA sponsored by
Employer X and is enrolled in X’s medical plan. D visits a physician’s office for
medical care as defined in § 213(d). The cost of the services provided by the

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physician is $150.00. Under the medical plan, D is responsible for 20% of the
services provided by the physician. X has coordinated with the medical plan and
X or its agent is automatically provided with an EOB from the plan indicating that
D is responsible for payment of 20% of the $150 (i.e., $30) charged by the
physician. Because X has received a statement from an independent third-party
that D has incurred a medical expense, the date the expense was incurred, and
the amount of the expense, the claim is substantiated without the need for D to
submit additional information regarding the expense. D has sufficient FSA
coverage for the claim, which was incurred during the coverage period. X’s FSA
reimburses D the $30 medical expense without requiring D to submit a receipt or
a statement from the physician.
B. Prohibition Against Self-Certification

Section 105 and § 125 require the substantiation of all medical expenses
as a precondition of payment or reimbursement (including the automatic
substantiation methods described in Rev. Rul. 2003-43 and this notice). “Self-
substantiation” or “self-certification” of an expense by an employee-participant
does not constitute the required substantiation.
For example, a health FSA or an HRA does not satisfy the requirements of
§ 105(b) if it reimburses participants for expenses where the participants only
submit information (including via internet, intranet, facsimile or other electronic
means) describing medical expenses, the amount of the expenses, and the date
of the expenses, but does not provide a statement from an independent third-
party (either automatically or subsequent to the transaction) verifying the

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expenses. Under § 1.105-2 of the regulations, all amounts paid under a plan that
permits “self-substantiation” or “self-certification” are included in gross income,
including amounts reimbursed for medical expenses whether or not
substantiated. See
Rev. Rul. 2002-80, 2002-2 C.B. 925 and Rev. Rul. 2003-43.
Similarly, “self-substantiation” or “self-certification” of an employee’s copayment
in connection with copayment matching procedures through payment cards or
otherwise does not constitute substantiation. If a plan’s copayment matching
system relies on an employee to provide a copayment amount without
independent verification of the amount, claims have not been substantiated, and
all amounts paid from the plan are included in gross income, including amounts
paid for medical care whether or not substantiated.
V. USE OF CARDS FOR DEPENDENT CARE ASSISTANCE PROGRAMS

An employer may use a payment card program to provide benefits under
its DCAP, including a dependent care FSA. However, dependent care expenses
may not be reimbursed before the expenses are incurred. For this purpose,
dependent care expenses are treated as having been incurred when the
dependent care services are provided, not when the expenses are formally billed,
charged for, or paid by the participant. Prop. Treas. Reg.
§ 1.125-1, Q & A-18. Thus, if a dependent care provider requires payment
before the dependent care services are provided, those expenses cannot be
reimbursed at the time of payment, even through the use of a payment card
program.
An employer offering a DCAP or dependent care FSA may nevertheless

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adopt the following method to provide reimbursements for dependent care
expenses through a payment card program. At the beginning of the plan year or
upon enrollment in the DCAP, the employee pays initial expenses to the
dependent care provider and substantiates the initial expenses by submitting to
the employer or plan administrator a statement from the dependent care provider
substantiating the dates and amounts for the services. After the employer or
plan administrator receives the substantiation, but not before the date the
services are provided as indicated by the statement from the dependent care
provider, the plan makes available through the payment card an amount equal to
the lesser of: (1) the previously incurred and substantiated expense, or (2) the
employee’s total salary reduction amount to date. See Prop. Treas. Reg. §
1.125-2, Q & A-7(b)(8). The amount available through the card may be
increased in the amount of any additional dependent care expenses only after
the additional expenses have been incurred. The amount on the card may then
be used to pay for later dependent care expenses.
Later card transactions that have been previously approved as to the
dependent care provider and time period may be treated as substantiated without
further review if the later card transactions are for an amount equal to or less
than the previously substantiated amount. If there is an increase to the
previously substantiated amount or a change in the dependent care provider, the
employee must submit a statement or receipt from the dependent care provider
substantiating the new claimed expense before amounts relating to the increased
amount or new provider may be added to the card.

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Example. Employer Z sponsors a dependent care FSA that is offered
through its cafeteria plan. Salary reduction amounts for participating employees
are made on a weekly payroll basis, which are available for dependent care
coverage on a weekly basis. As a result, the amount of available dependent care
coverage equals the employee’s salary reduction amount minus claims
previously paid from the plan. Z has adopted a payment card program for its
dependent care FSA. Employee F is a participant in the dependent care FSA
and has elected $5,000 of dependent care coverage. Z reduces F’s salary by
$96.15 on a weekly basis to pay for coverage under the dependent care FSA.
At the beginning of the plan year, F is issued a debit card with a balance
of zero. F’s childcare provider, ABC Daycare Center, requires a $250 advance
payment at the beginning of the week for dependent care services that will be
provided during the week. The dependent care services provided for F by ABC
qualify for reimbursement under § 129. However, because the services have not
yet been provided as of the beginning of the plan year, F cannot be reimbursed
for any of the amounts until the end of the first week after the services have been
provided. F submits a claim for reimbursement that includes a statement from
ABC with a description of the services, the amount of the services, and the dates
of the services. Z increases the balance of F’s payment card to $96.15 after the
services have been provided (i.e., the lesser of F’s salary reduction to date or the
incurred dependent care expenses). F uses the card to pay ABC $96.15 on the
first day of the next week and pays ABC the remaining balance due for the week
($153.85) by check.

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To the extent that this card transaction and each subsequent transaction
is with ABC and is for an amount equal to or less than the previously
substantiated amount, the charges are fully substantiated without the need for
the submission by F of a statement from the provider or further review by the
employer. However, the subsequent amount may not be made available on the
card until the end of the week when the services have been provided.
EFFECTIVE DATE
With respect to the Inventory Information Approval System, as described
in section III B of this notice, the requirement that an employer that uses this
system is responsible for ensuring that the system complies with the
recordkeeping requirements of this notice (including Rev. Proc. 98-25) is
effective for plan years beginning after December 31, 2006.
EFFECT ON OTHER DOCUMENTS
Rev. Rul. 2003-43, 2003-1 C.B. 935, is amplified.
DRAFTING INFORMATION
The principal author of this notice is Barbara Pie of the Office of Division
Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For
further information regarding this notice, contact Mireille T. Khoury on (202) 622-
6080 (not a toll free call).