IRS FSA rule trips up many retail pharmacies

December 11, 2009

Retail pharmacy managers are discovering that many third-party administrators do not agree that their inventory information approval systems meet compliance requirements set by the Internal Revenue Service for customers' use of flexible spending accounts.

Key Points

Shelly Bailey, pharmacist-manager at Central Drugs in Portland, Ore., felt she met all the compliance requirements for inventory information approval systems (IIASs) set by the Internal Revenue Service for her customers' use of their flexible spending accounts (FSAs). An IIAS system had to be in place by July 1, 2009, and she was ready.

Little did she - or thousands of other independent and small chain pharmacies nationwide, according to the National Community Pharmacists Association (NCPA) - know that many third-party administrators would not agree that her IIAS met the standards set by the IRS's point-of-sale (POS) technology allowing the tax-exempt purchases. So many of her customer's purchases, including co-pays and deductibles, were not allowed under the FSA tax-exempt rule.

Since July 1, IRS rules have mandated that in order to continue processing FSA debit-card transactions, pharmacies must operate an IIAS that meets the certification requirements of the Special Interest Group of IIAS Standards (SIGIS). In order to process these FSA transactions, pharmacies have to use a point-of-sale (POS) technology that is SIGIS compliant. But the IRS created an exception: Pharmacies do not need the expensive POS technology if they meet the IRS's 90 percent rule, which exempts them from the IIAS-SIGIS requirement.

The full-version POS technology isn't cheap: It can cost tens of thousands of dollars. So for Bailey and other managers of independent and small chain drugstores, the exemption was very important to customer relations and to their bottom line.

The advantage to the customers was clear: Whatever they charged to their cards that was listed by the IRS - band-aids, aspirins, all OTC health-related products, along with prescription co-payments and deductibles - could come directly from the tax-exempt FSA accounts. The advantage to the independents and small chain stores was also clear: They did not need to spend the many thousands of dollars full POS systems can cost.

But Bailey and others were shocked to learn from many third-party administrators, the people who actually handle the FSA accounts, that their customers' purchases apparently did not meet the IRS requirements, including the 90 percent rule.

"When customers found out that their supplies did not meet the rule, many were very upset. It hurt our business," said Bailey. "They began to question what other mistakes we were making. And some were even told by their employers to take their business elsewhere."

Visa is one of the third-party administrators that handle FSA accounts. A company representative said Visa is aware of the problem and is attempting to come up with a solution.

But NCPA is not waiting. Some of its members' customers are being told by their employers and other third-party administrators to shop at other pharmacies that have POS IISA-compliant software. So in a letter to the IRS, NCPA has made two proposals that it hopes will help to create "a level playing field for FSA purchases" at independent stores and small chains:

"It's in the IRS's hands now," said John Coster, NCPA's senior vice president for government affairs. "We can only hope they take into consideration the detrimental effect lack of proper enforcement of their existing rules is having on community pharmacies."

Martin Sipkoff is a healthcare writer in Gettysburg, Pennsylvania.

The article above from the December 2009 issue was updated on February 18, 2010 to correct an error.