IRS Addresses Section 213 Medical Expense Deduction and Direct Primary Care Arrangements

Practical Law Legal Update w-025-9478 (Approx. 9 pages)

IRS Addresses Section 213 Medical Expense Deduction and Direct Primary Care Arrangements

by Practical Law Employee Benefits & Executive Compensation

Section 213 Deduction for Medical Expenses

As background, Code Section 213(a) permits a deduction for expenses paid during the tax year (if not compensated for by insurance or otherwise) for medical care for an individual (or the individual's spouse or dependents) (26 U.S.C. § 213(a)). "Dependent" for this purpose is defined under Code Section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) (26 U.S.C. § 152). These deductible expenses are capped at either:

10% of adjusted gross income (AGI).
7.5% of AGI for tax years beginning before January 1, 2021.

The Section 213 deduction is permitted only as to medical expenses that are actually paid during the tax year, regardless of:

When the event that led to the expenses occurred.
The accounting method used by an individual for filing income tax returns.

Medical care for this purpose includes amounts paid for:

The diagnosis, cure, mitigation, treatment, or prevention of disease, or to affect any structure or function of the body (referred to as medical care under Section 213(d)(1)(A)).
Transportation that is primarily for and essential to obtaining medical care (as described in the first bulleted item above).
Qualified long-term care services.
Insurance for medical care and transportation (as described in the first two bulleted items above, respectively) (that is, medical insurance), including:
- supplementary medical insurance for the elderly (Medicare Part B premiums); and
- qualified long-term care insurance contracts (see Medical Insurance for Section 213 Purposes).

(26 U.S.C. § 213(d)(1); see Practice Note, COBRA Overview: Medical Care.)

Medical care under Section 213(d)(1)(A) may include:

Hospital or nursing services.
Medical, laboratory, surgical, dental, and other diagnostic and healing services.
Obstetrical and therapy expenses, and X-rays.
Prescribed drugs or insulin.
Artificial teeth or limbs.

Expenses that are merely beneficial to an individual's general health (for example, vacation expenses) are not expenses for medical care.

Medical Insurance for Section 213 Purposes

Expenses for medical insurance (under Code Section 213(d)(1)(D)) are amounts paid for medical care if the amounts are paid for insurance:

That covers the diagnosis, cure, mitigation, treatment, or prevention of disease.
To affect any structure or function of the body.
For transportation that is primarily for and essential to medical care.

(26 U.S.C. § 213(d)(1)(D); 26 C.F.R. § 1.213-1(e)(4)(i)(a).)

Implementing regulations under Code Section 213 impose additional restrictions involving insurance contracts if amounts may be paid under the contracts for non-medical-care purposes (for example, indemnity contracts) (26 C.F.R. § 1.213-1(e)(4)(i)(a)).

Relying in part on a forerunner to Section 213 (Code Section 23x), the IRS indicated in its proposals that the term "insurance" for Section 213 purposes should be interpreted broadly. For example, the IRS has included that amounts paid for membership in a health maintenance organization (HMO) are treated as medical insurance premiums. General insurance principles under Subchapter L of the Code do not control this determination.

Direct Primary Care Arrangements

Under the proposed regulations:

Expenses for DPCAs and HCSM memberships would be amounts paid for medical care as defined in Code Section 213(d).
Amounts paid for those arrangements would be deductible medical expenses under Code Section 213(a).

Under the proposed regulations, a DPCA is a contract between an individual and a primary health care provider under which the provider agrees to furnish medical care (as defined in Code Section 213(d)(1)(A)) for a set annual or periodic fee without billing a third party. (The IRS seeks comments on whether this definition also should include contracts involving nurse practitioners, clinical nurse specialists, and physician assistants.)

An arrangement between an individual and a dentist for dental care would not fall under the DPCA definition, although such an arrangement could provide Section 213(d) medical care.

A DPCA may be a payment for medical insurance or medical care under Section 213(d). For example, this could include:

Payments that solely provide for an anticipated course of specified treatments for a condition.
An arrangement that provides exclusively for an annual physical condition.

However, a DPCA that is characterized as medical insurance has consequences under the Code's rules governing health savings accounts (HSAs) (see HSA Considerations: General Rule and Limited Exceptions).

HRA Considerations

Under the proposed regulations, a health reimbursement arrangement (HRA) and certain similar arrangements generally may reimburse expenses for medical care as defined under Section 213(d). As a result, an HRA may reimburse DPCA fees. This treatment applies to:

Qualified small employer health reimbursement arrangement (QSEHRAs) (see Practice Note, Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs)).
HRAs that are integrated with a traditional group health plan. For more information, see:
HRAs that are integrated with individual health insurance coverage or Medicare (ICHRAs) (see Practice Note, Individual Coverage Health Reimbursement Arrangements (ICHRAs)).
Excepted benefit HRAs (EBHRAs) (see Practice Note, Excepted Benefit Health Reimbursement Arrangements (EBHRAs)).

HSA Considerations: General Rule and Limited Exceptions

For individuals in DPCAs, the type of coverage provided by the DPCA affects whether the individual is an eligible individual for purposes of the HSA rules under Code Section 223 (26 U.S.C. § 223; see Practice Note, Defined Contribution Health Plans: Health Savings Accounts (HSAs)).

Most DPCAs may provide for an array of primary care services and items (for example, physical examinations, vaccinations, urgent care, laboratory testing, and the diagnosis and treatment of sickness or injuries). Such DPCAs are health plans or insurance that provides coverage:

Before the minimum annual deductible is met.
That is not disregarded coverage or preventive care for purposes of the Code's HSA rules.

As a result, an individual who is covered by a DPCA generally is ineligible to contribute to an HSA.

As an exception, however, the IRS recognized that in limited circumstances an individual may be covered by a DPCA that either:

Does not provide coverage under a health plan or insurance (for example, the DPCA solely provides for a planned course of specified treatments of an identified condition).
Provides only disregarded coverage or preventive care under the Code's HSA rules (for example, an annual physical examination).

In these circumstances, an individual would not be prohibited from contributing to an HSA solely due to participation in the DPCA.

If the DPCA fee is paid by an employer, that payment arrangement is a group health plan and the group health plan itself (not the DPCA) disqualifies the individual from contributing to an HSA.

Health Care Sharing Ministries

The proposed regulations define an HCSM as an organization:

Described in Code Section 501(c)(3) that is tax-exempt under Section 501(a) (26 U.S.C. § 501(a), (c)).
The members of which share a common set of ethical or religious beliefs, and share medical expenses among members:
- consistent with those beliefs; and
- without regard to the state in which a member resides or is employed.
The members of which keep their membership after developing a medical condition.
Which has been in existence at all times since December 31, 1999.
The members of which have shared medical expenses continuously and without interruption since at least December 31, 1999.
Which conducts an annual audit that is:
- performed by an independent certified public accounting firm consistent with generally accepted accounting principles; and
- made available to the public on request.

(26 U.S.C. § 5000A(d)(2)(B)(ii) (addressing the Affordable Care Act's (ACA's) individual mandate); see Legal Update, Fifth Circuit Affirms Ruling That ACA's Individual Mandate Is Unconstitutional, But Orders Do-Over of District Court's Severability Analysis.)

In contrast to DPCAs, HCSMs do not furnish medical treatment or services that are medical care for Section 213(d) purposes. Rather, HCSM membership permits individuals to:

Share their medical bills through the ministry.
Possibly receive payments from other members to help with their medical bills.

HCSM Payments Treated as Medical Insurance

Although HCSM membership payments are not for medical care under Section 213(d), the proposed regulations would allow amounts paid for HCSM membership to be payments for medical insurance under Section 213(d). In this regard, the IRS reasoned that HCSMs are intended to allow members to share their medical expenses with other members. Under an HCSM, members:

Help pay other members' medical bills.
May be reimbursed for their own medical bills in return.

As a result, the IRS reasoned that HCSM transactions are substantively similar to traditional medical insurance premiums.

HRA and HSA Considerations for HCSMs

HCSMs cannot be integrated with ICHRAs (see Practice Note, Individual Coverage Health Reimbursement Arrangements (ICHRAs): Integrating HRAs and Individual Market Health Insurance Coverage).

As noted above regarding DPCAs, HRAs generally may reimburse expenses for Section 213(d) medical care. The proposed regulations also would permit HRAs (including HRAs integrated with a traditional group health plan, ICHRAs, QSEHRAs, and EBHRAs) to reimburse payments for membership in an HCSM as a medical care expense under Section 213(d).

Because HCSMs are medical insurance under Section 213(d)(1)(D) that is not permitted insurance under the HSA rules, HCSM membership prohibits individuals from contributing to HSAs.

HMOs and Government-Sponsored Health Care Programs

Under the proposed regulations, amounts paid for arrangements such as HMOs and certain government-sponsored health care programs would be amounts paid for medical insurance under Code Section 213(d)(1)(D) (26 U.S.C. § 213(d)(1)(D)). By contrast, amounts paid to an HMO or provider to cover coinsurance, copayment, or deductible obligations under an HMO's terms are payments for medical care for Section 213 purposes.

In addition, amounts paid for coverage under certain government-sponsored health care programs are classified as medical insurance for Section 213 purposes. This treatment would extend to:

Medicare Parts A, B, C, and D (see Practice Note, Medicare Part D Creditable Coverage Disclosures and Group Health Plans).
Medicaid, TRICARE, and the Children's Health Insurance Program (CHIP).

As a result, if one of these government-sponsored health programs requires individuals to pay premiums or enrollment fees for coverage under the program, the amounts may be deducted as Section 213 medical expenses.

Practical Impact

The IRS's proposed regulations clarify issues regarding DPCAs that have been the source of confusion for health providers, some employers, and individuals. Comments on the proposals, which may be submitted in written or electronic form, must be received by the IRS by August 10, 2020.

Notably, the proposed regulations do not address whether DPCAs or HCSMs or related payments are employee welfare benefit plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). (Those issues fall under the Department of Labor's jurisdiction.) However, the DOL indicated to the IRS that an employer's funding of a DPCA or HCSM generally would be enough to make such an arrangement subject to ERISA to the extent it provides health benefits to employees.

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