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Debit cards problems for small business health plans

by Tony Novak, CPA, MBA, MT
, revised 11/20/2011

In response to the growing popularity of consumer driven health plans, the IRS issued new compliance guidelines for employers who elect to use bank debit cards to allow employees to pay for health care expenses. These debit cards are popular features in uninsured plans like Health Reimbursement Account (HRA) and Medical Savings Account (MSA) plans because of the convenience to employees. Some speculate that debit cards will be a popular feature in the newly authorized Health Savings Accounts (HSA) expected to debut in 2004. But there are serious tax and administrative downsides that can easily outweigh the benefits to using health plan debit cards.

The first drawback is that debit cards are expensive. An employer usually operates a group health plan at minimal administrative expense, usually less than $50 per employee per year. The addition of debit cards to an HRA plan typically increases the cost per employee from about $50 to about $110 per year, based on observations of currently operating debit card plans.

Second, the use of debit cards almost always requires outside assistance from a third party administrator. While most employers can easily administer a health plan without a debit card, the addition of the debit card system requires the appointment of a third party plan administrator. If part of the goal of the group health plan is to “keep it simple,” then bringing in an extra layer of management and expense is certainly not the solution.

Third, the debit card increases the difficulty of IRS compliance. Consider a plan that issues a check to each employee along with payroll. This amounts to four transactions per employee per year that can be justified with the employees signature obtained when the employee picks up the check. But now consider a debit card, where there could be dozens of transactions. Now dozens of transactions must be traced and validated and the burden of this verification shifts from the employee to the employer.

Fourth, debit cards can be subject to overdraft charges just like any other bank account. This can add additional fees and create ill will among employees who incur the charges as well as medical providers with unpaid bills. If the spouse of an employee, for example, forgets that she gave the card to the family chiropractor for weekly wellness visits for family members and then loses track of the account balance, there could easily be more than a hundred dollars of overdraft fees before the problem is caught and corrected. There are actual examples of accounts in MSA plans where the amount paid to cover bank fees was more than the amount paid for medical expense. Not only is this a waste of employer funds, but this creates additional tax and administrative expense. Since bank fees are not a qualifying medical expense, the amount of bank fees must be recalculated as taxable wages.

Fifth, debit cards should be combined with Preferred Provider health discount cards for maximum effectiveness. Most debit card plans do offer this feature. But the problem is that the best PPO discount plans available on the market today are not available in combination with debit cards. So this means that employers who use these bundled health plans overpay for a PPO discount plan that offers less than the best discounts to employees.

The IRS recently issued guidelines for health plans using debit cards for reimbursing qualified medical expenses. If you do use a debit card system, make sure that it meets the following standards:

1) Certify participant eligibility for each transaction and de-activate cards for terminated employees or individuals who make charges for ineligible expenses.

2) Have the card limited to eligible health care providers by merchant category code.

3) Automatically adjudicate every claim with other health insurance and manually check claims that cannot be adjudicated automatically.

4) Pay claims from participant-owned credit or debit accounts or obtain taxpayer identification number information from the medical provider.

5) Comply with HIPAA electronic data interchange requirements and ERISA trust and plan asset rules.

6) Check contractual representations and warranties by the plan administrator for provisions to indemnify the employer for all compliance issues.

Freedom Benefits recommends that employers avoid the use of employer-provided debit cards in health plans. A better system is to simply include an additional tax-free medical payment either with payroll or as a separate check as an employee reimbursement. This type of reimbursement plan can be easily incorporated into any existing health plan and payroll accounting system.

 The employer may obtain a simple written verification from the employee that the funds are used for tax-qualified medical expenses in order to meet IRS compliance requirements. More information is included in the employer’s health plan administrative guide available at www.FreedomBenefits.org.

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