Segal's June 2, 2003 Capital Checkup

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June 2, 2003

IRS ISSUES GUIDANCE ON THE DEDUCTIBILITY OF
CERTAIN MEDICAL EXPENSES

The Internal Revenue Services (IRS) has recently released two revenue rulings and one private letter ruling that state whether certain expenses are considered "medical care" under Section 213 of the Internal Revenue Code (IRC). The guidance addresses deductibility of the following:

Nonprescription drugs and supplies,
Breast reconstruction,
Laser eye surgery,
Teeth whitening, and
Egg donor costs

What is IRC Section 213?

Under Section 213 of the IRC, items that are considered medical care under the IRC, which are not covered by insurance, can be deducted by taxpayers to the extent that the expenses exceed 7.5 percent of adjusted gross income. In addition, only those items considered medical care under Section 213 are reimbursable under a health flexible spending arrangement (FSA) or a health reimbursement arrangement (HRA).

Nonprescription Drugs and Supplies

In Revenue Ruling 2003-58, the IRS concluded that medicines obtained without a prescription are not deductible under Section 213. Section 213(d) only permits a deduction for prescribed drugs or insulin. Thus, taxpayers cannot deduct the cost of a nonprescription medication, even if a physician recommends the medication. For example, the cost of aspirin is not deductible or reimbursable from an FSA, even if a doctor prescribes aspirin. As more and more drugs that used to require a prescription are now available without a prescription, such as Claritin, the ruling means that individuals will not only lose their health plan coverage for the drugs, but also cannot receive reimbursement for it from their FSA or HRA.

In contrast, the IRS stated that certain medical equipment, supplies and diagnostic devices may be expenses for medical care deductible under Section 213. Under Section 213(d)(1), "medical care" includes amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body. The IRS concluded that items such as crutches and bandages mitigate the affect of an individual's injury and are deductible. Also, kits for testing blood sugar are also deductible because they monitor diabetes and assist individuals in treating the disease.

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Breast Reconstruction, Laser Eye Surgery and Teeth Whitening

In Revenue Ruling 2003-57, the IRS stated that breast reconstruction surgery following the removal of a breast as part of cancer treatment, and laser eye surgery to correct myopia are both deductible medical expenses under Section 213. Although cosmetic surgery is generally not considered "medical care," in the case of breast reconstruction following cancer surgery, the reconstruction ameliorates a deformity that is directly related to a disease. Therefore, it is an expense for medical care. Laser eye surgery (such as LASIK and radial keratotomy) is also deductible because it corrects a dysfunction of the body. Teeth whitening, however, is not deductible under the IRC because it does not treat a physical or mental disease or promote the proper function of the body.

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Egg Donor Costs

In Private Letter Ruling 200318017, released on May 2, 2003, the IRS responded to a request from an individual taxpayer about whether expenses associated with using an egg donor are medical expenses under Section 213 of the IRC. The letter ruling states that, in addition to the direct cost of treatment for production and harvesting of the eggs, the following are covered medical expenses:

The donor's fee for her time and expense in following proper procedures to ensure a successful egg retrieval,
The agency fee for getting the donor and coordinating the transaction,
Expenses for prior medical and psychological testing of the donor as well as medical and psychological assistance for the donor that is needed after the procedure, and
Legal fees for preparing a contract with the donor.

The IRS reasoned that the donor expenses are expenses in preparation for a procedure that facilitates pregnancy by overcoming infertility. Thus, it affects a structure of the body and is considered medical care. The legal expenses are deductible as medical care because there is a direct and proximate relationship between the legal expenses and the provision of medical care to a taxpayer. Although this decision technically only applies to the taxpayer who requested it, those who seek an egg donor will welcome it because expenses associated with egg donation may not be covered by health plans. However, because this ruling is not binding with regard to others, employers considering allowing reimbursement from FSAs or HRAs for these expenses might want to seek their own letter rulings on the issue.

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Summary of Guidance

For quick reference, the following table summarizes the recent IRS guidance:

EXPENSE	IS IT DEDUCTIBLE/ REIMBURSEABLE?
Over-the-counter drugs recommended by a doctor	No
Medical equipment, supplies and diagnostic devices	Yes
Breast reconstruction	Yes
Laser eye surgery	Yes
Teeth whitening	No
Egg donor costs	Yes

Capital Checkup is The Segal Company's periodic electronic newsletter summarizing activity in Washington with respect to health care and related subjects. Capital Checkup is for informational purposes only. It is not intended to provide guidance on current laws or pending legislation. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.