Can Debit-Card Issuers Limit Acceptance to Certain Sites?

This column is an excerpt (Question 117) from a book to be published later this year to help guide account owners, employers, benefits managers, and administrators understand Health Savings Account compliance issues. The format consists of a common question, an explanation in easy-to-understand English (often with an appropriate example), and citation from government documents to support the answer. The book is designed to inform. It is not a legal document, and the contents should not be construed as legal advice.

Question: I recently received my Health Savings Account debit card. It works only at certain locations most likely to sell qualified products and services. I thought I could make withdrawals for any purpose, subject to taxes and possible penalties. Can an account provider restrict the range of items that I can purchase with the debit card?

Answer: Yes. Most leading Health Savings Account providers configure their cards to limit purchases to certain qualified items and merchants, following industry best practices.

Your account provider must offer you an alternative method to withdraw funds. The most common options are a distribution form or an online request to send funds to you either by paper check (becoming less common) or direct deposit. Your account provider must honor all requests for withdrawals from the account and can’t limit distributions to qualified expenses (see Question 118).

How Health Savings Account Debit Cards Are Merchant-Coded

Why do account providers incorporate this coding into the card? They want to help you use the card for qualified expenses only. Account providers (or sometimes employers) choose to configure debit cards in one of three ways:

Coded. The card is configured so that you can purchase only HSA-qualified items or use the card only at retail locations that sell mostly HSA-qualified items (places like doctor’s offices, hospitals, labs, imaging centers, chiropractors, acupuncturists, pharmacies, dental offices, and optical shops). Account providers that adopt this approach want to limit the likelihood that you use the card for non-qualified expenses. Coding doesn’t eliminate your purchasing a non-qualified expense. For example, you can purchase non-prescription sunglasses at an optical shop or teeth-whitening products or services at a dental office. But the coding minimizes your compliance risk.

The coded card is emerging as an industry best practice. They not only increase owners’ compliance with federal tax law but also offer superior protection against fraud because their acceptance is limited. Thieves are most likely to abandon a stolen card quickly if they can’t use it to buy expensive items like furniture, cruises, and electronic devices at brick-and-mortar or online merchants. Thieves may be good at their trade, but they typically don’t know enough about employee benefits, the tax code, and debit-card coding to drain your account with the online purchase of contact lenses or a quick trip to the dentist for an implant or root canal.

Health FSA cards must carry the restrictive coding, since distributions are limited to qualified expenses.

Coding limited to retail locations. You can use the card to purchase any item at any retail location, but you can’t withdraw cash from your account at a bank or ATM. This coding approach is designed to protect you from cash withdrawals that offer no effective paper trail to link the distributions to qualified expenses. It gives you the flexibility to use the card to buy qualified and non-qualified goods and services. But it removes the guardrails of a coded card, which helps you determine which expenses are qualified.

This configuration makes it easier for account owners who want to use their balances for non-qualified expenses (whether they intend to pay taxes and possible penalties or want to pair the withdrawal with a prior qualified expense not reimbursed) to use their Health Savings Account debit card rather than pay with personal funds and request a reimbursement from their account provider.

No coding. You can use the debit card to purchase any item at any time or withdraw cash from your account. Some account providers issue uncoded debit cards because account owners are permitted to withdraw funds for any purpose (subject to adverse tax consequences if the expense isn’t qualified). Moreover, you can reimburse yourself from your Health Savings Account for a qualified expense that you paid with another form of tender by purchasing a non-qualified item with your debit card. These providers don’t want to deprive account owners like you of the flexibility and choice that a wide-open configuration allows. The trade-off is that your compliance risk is greatest when your card works at all merchant locations and at ATMs.

This coding is most common among smaller banks and other financial institutions that don’t possess the technology to limit purchases to qualified expenses or merchants. They issue general debit or credit cards for standard checking accounts for which the tax code doesn’t treat various withdrawals differently. In contrast, account providers who also administer Health FSAs or Health Reimbursement Arrangements with debit cards can easily apply restrictive coding to their Health Savings Account debit cards as well because this coding is required on cards attached to those reimbursement accounts.

 Resource

IRS Notice 2008-59:

 Q-27. May an HSA be administered through a debit card that restricts payments and reimbursements to health care?

A-27. Yes, if the funds in the HSA are otherwise readily available. For example, in addition to the restricted debit card, the HSA account beneficiary must also be able to access the funds other than by purchasing health care with the debit card, such as through online transfers, withdrawals from automatic teller machines or check writing. Employers must notify employees that other access to the funds is available.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.

HSA Question of the Week is published every week, alternating every other Wednesday with HSA Wednesday Wisdom and every other Monday with HSA Monday Mythbuster.