FSA Debit Card - IRS Requirements

IRS Requirements

Under IRS Revenue Ruling 2003-43, every transaction on an FSA debit card must be either substantiated or recouped from the employee. Substantiation can be through either electronic evidence (auto-adjudication) or paper receipts submitted by the user (similar to paper claims). The process of obtaining receipts or recoupment when auto-adjudication is not possible is known as "pay and chase", a term the IRS also used in its most recent ruling (Notice 2007-02).

The most common method of auto-adjudication is known as "copay matching". Under Ruling 2003-43 as amplified by Notice 2006-69, the FSA or HRA provider must obtain from the employee's health plan the standard copayment amounts for that plan. If the charge is exactly equal to between one and five of those copayment amounts, it may be auto-adjudicated and approved without receipts. If the health plan has different copayment amounts for a particular type of charge, any valid combination of copayment amounts may be approved, up to five times the highest possible copayment amount.

Also, charges may be auto-adjudicated if they are accompanied by electronic information substantiating that the charge is for medical purposes. This may be done through such means as including details of the transaction with the charge (Ruling 2003-43) or forwarding the health plan's explanation of benefits to the FSA or HRA provider for further processing (Notice 2006-69).

Under Notice 2006-69, all charges from a merchant with an IIAS may also be auto-adjudicated; however, beginning in 2007 the merchant must make available to the employer the detailed records of all such transactions for IRS review. This may be done either automatically or in response to an IRS audit of the employer.

If the charge is not substantiated by auto-adjudication or receipts, the FSA or HRA provider must recoup the charge and suspend the card until it is recouped. In addition to voluntary methods of recoupment, employers commonly use payroll deduction, as well as offsetting the recoupment against future paper claims. If all else fails, the employer may add the amount of the charge to the employee's W-2 as taxable income.