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alidating Small Business Health Plan Claims
By Tony Novak, MBA, MT, www.tonynovak.com, OnlineAdviserTM at FreedomBenefits.org
The tax code has always held that a business must be able to substantiate the deductions taken from its income. Usually this means keeping a copy of the invoice and receipt or cancelled check for the expenses. When it comes to health care expenses, the IRS also requires that the expenses fall into the deductible definitions listed in Publication 502 as "medically necessary". Most small firms use a health insurance or managed care company to handle all of these functions. But the growing number of small business employers using Flexible Reimbursement Account (FSA) plans, Cafeteria Plans or Healthcare Reimbursement Arrangement (HRA) plans now face the issue of substantiating employee medical claims.
This issue is complicated by the recent legislation protecting the privacy of medical information. There is potential legal liability for an employer who comes into possession of an employee's medical information. Employers complain that they are required to validate private information about employees they would rather not know.
The IRS remains focused on avoiding tax abuse in medical plans. It fears that modern health plans allow participants to access tax-free cash for non-medical purposes. Recent IRS publications about health plans have consistently emphasized the need for employers to validate medical plan claims. At a recent benefits industry conference, one IRS official was quoted as saying that the only way to validate medical plan expenses was to utilize a third party administrator. Of course the firms providing this service now cite this reference as a justification of their fees. Some have gone as far as saying that any uninsured health plan without a professional third party administrator does not meet tax law requirements. This is nonsense.
The medical plans under scrutiny by the IRS are primarily those that provide a debit card for employees to access cash without the employer's knowledge. Most small business health plans do not use this feature. A new wave of small business health care plans is gearing up to provide this service to small firms at substantial fees. The lure of these debit cad plans is that the plan administrator essentially loans the cash to employees when they make a debit card withdrawal and then bills the employer at a later date. This is viewed as a lucrative market for many financial institutions. Most small businesses should avoid the sales pitch of these plans in favor of an easier and less expensive health plan.
Substantiation of medical claims can still be handled easily with a written employee statement. This continues to be the best method for the majority of small business health plans. Although the IRS has not specifically commented on this issue, the written statement can probably be made after the employee has accessed the cash from the health plan. For example, a common health plan design makes $2000 available to each employee from employer general funds for health care expenses on January 1 and then requires a written statement to validate any expenses taken under the plan by December 31 or the same year. This method is similar to the way that many firms handle petty cash accounts. The written statement should provide boilerplate language that the employee has adequate records (receipts) of transactions and has received and reviewed a copy of IRS Publication 502. Of course, an employee "statement" may be on paper or online, whichever method works best for the specific business. Additionally, it is smart for employers to provide an additional external resource for employees who may have questions. The primary advantage of his plan design is that there are no ongoing fees or third party services required.
Freedom Benefits Association provides a prototype medical expense claim form with any low cost benefit plan start-up kit. An online claim validation service will be launched before the year end as an additional option for 2004 health plans.
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