November 14, 2017
To borrow from the opening lines of this court opinion, this article is about a tax case. Fear not, keep reading. The question: are the expenses of an egg donor and surrogate pregnancy “medical expenses” under Section 213 of the tax code for the person who hires them? The answer matters for health plans and account-based reimbursement plans like health flexible spending accounts (FSAs), health reimbursement arrangements (HRAs), and health savings accounts (HSAs).
In the case, the taxpayer and his same-sex partner were looking to have children. They chose to use in vitro fertilization (IVF) using an egg harvested from an egg donor and that would subsequently be brought to term using a surrogate mother. The taxpayer took a tax deduction for all expenses associated with the IVF procedure, of identifying egg donor, and of the surrogate mother. The IRS rejected most of the expenses since they were not related to the taxpayer’s own body, but instead related to the egg donor and surrogate mother.
Under Section 213 of the tax code, a taxpayer can deduct, as an itemized expense, medical expenses incurred in a year to the extent they exceed 10% of his or her adjusted gross income (prior to 2013, the threshold was 7.5%). However, consistent with prior cases and IRS guidance, the court held that the expenses for locating an egg donor and for the medical care of the surrogate mother were not deductible by the taxpayer. As explained in the case, the tax code limits the deduction to medical care for the taxpayer’s body (or the bodies of the taxpayer’s spouse or dependents). Consequently, the court ruled that none of the expenses for locating an egg donor or caring for the surrogate were deductible by the taxpayer under this standard. (The court does not address this, but presumably the surrogate mother could have deducted expenses for her own care, if they exceeded the threshold.)
Although the Section 213 deduction is not directly relevant to employers, the definition of medical expenses carries important implications for employers. Specifically, Section 213(d) is the definition that is used to determine if a medical expense can be reimbursed tax-free under a health plan or other tax-favored accounts, such as FSAs, HRAs, and HSAs.
Takeaways
While this result isn’t new, it is a good reminder. To the extent these expenses are reimbursed by a health plan, they are taxable to the recipient, similar to the way that elective, non-Section 213(d)-compliant plastic surgery expenses covered by a health plan would be taxable to the recipient.
Moreover, if an FSA or HRA were to reimburse for these medical expenses, the IRS could invalidate the accounts, making them taxable to all participants. Worse still, if the IRS invalidated the tax-favored status of such accounts, the amounts would become taxable compensation and the employer would also become liable for any underwitholding associated with that additional compensation. Therefore, these medical expenses should not be reimbursed from those accounts.
For HSAs, participants who seek reimbursement of these medical expenses from their HSAs will be subject to tax on the amount plus the 20% penalty for withdrawals that are not for medical expenses. While employers should not restrict employees’ ability to access their HSA funds, employers may want to educate employees that these types of expenses are not proper medical expenses under the tax code. Employees can then decide for themselves whether they want to use their HSA funds for this purpose.
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NOTICE OF DISCLAIMER
The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.