In May, the IRS issued a private letter ruling to an individual taxpayer regarding the deductibility of 23andMe’s at-home DNA test kits under section 213(d) of the Code, which permits the deduction of medical expenses.  In the ruling, the IRS determined that an allocable portion of the purchase price may be treated as a deductible medical expense and the taxpayer may use a medical flexible spending account to purchase the kit.

23andMe provides a DNA collection kit that is used to collect a DNA sample from an individual and to send the sample to 23andMe for genetic testing.  The sample is then tested by a third-party laboratory.  The genetic information from the test is then analyzed by 23andMe and a report is provided to the individual with results from the laboratory and general information regarding genetic health risks, carrier status, wellness, and traits. The individual may then provide the information to a healthcare provider for additional testing, diagnosis, or treatment.

The IRS determined that the health services provided by 23andMe may be deductible medical expenses based on three revenue rulings, Revenue Ruling 54-457, Revenue Ruling 71-282, and Revenue Ruling 2007-72.  Revenue Ruling 54-457 determined that an allocable share of a lump-sum fee charged by a university for medical care and other expenses is eligible for deduction under section 213(d). Revenue Ruling 71-282 holds that the fee paid for storage of medical information in a computer data bank is deductible under section 213(d). Revenue Ruling 2007-72 determined that full-body scans performed without a doctor’s recommendation and for an individual experiencing no symptoms falls within the broad definition of “diagnosis,” which encompasses determinations that a disease may or may not be present, and includes testing of changes to the function of the body that are unrelated to disease.

Because an individual cannot purchase 23andMe’s health services without ancestry services, the IRS ruled that the cost of the kit is a medical expense only if it is purchased for the health services.  In other words, an individual who purchases the stand-alone ancestry services for $99 is not entitled to any deduction despite the fact that the DNA collection may be a medical expense if purchased for health services.  The fact that 23andMe sells stand-alone ancestry services strongly suggests that an individual purchasing the $199 ancestry and health services did so for the health services.  Accordingly, the deductible portion of the expense may exceed the $100 cost differential between the two services because some of the services provided in the stand-alone ancestry kit, such as DNA collection, become medical expenses when purchased for the health services.  Nonetheless, the ruling is specific in its directive that the taxpayer must use a reasonable method to allocate the cost of the health services between those that are medical care and those that are not.

Sponsors of health care FSAs should consider how to process reimbursement requests for 23andMe and similar DNA test kits.  It may be difficult to permit the use of FSA debit cards to purchase such kits until retailers easily allow for only the medical expense to be paid using the debit card and another payment method to be used for the ancestry expense.  23andMe has posted the ruling on its website and unveiled a calculator to help purchasers determine the deductible portion of the cost.  According to 23andMe, if a taxpayer purchased the health component of the health and ancestry services for the purpose of receiving the health predisposition, carrier status and wellness reports, and did not view the traits reports as having any independent value, then 23andMe indicates that approximately $117 plus shipping and tax paid may be eligible as medical care expense.  In contrast, 23andMe’s calculator indicates that if the taxpayer would have paid separately for the traits report, the amount that the taxpayer would have been willing to pay for the traits report reduces the eligible amount dollar-for-dollar because the traits report does not qualify as a medical care expense.  Although the company’s FAQs provide some insight into how 23andMe determined the portion of the cost that may be medical care expense, the IRS has not addressed whether its methodology is reasonable.

The reach of the ruling may extend well beyond genetic testing kits.  It signals the IRS’s willingness to consider reasonable allocations between medical expenses for health care and personal expenses when the benefits are bundled, such as the situation when a consumer purchases a smartwatch that supports health apps, such as heart rate and ECG monitors, fall detection, and blood glucose monitors.  When a consumer purchases a DNA kit for both ancestry and genetic testing, the health benefit is actually the provision of additional information to the individual so that he or she can seek professional advice if the health report reveals genetic risk for disease.  In the case of health apps on smartwatches, the goal is identical.  The wearer is given information about his health, which encourages him or her to seek out medical care to prevent disease before it strikes, which is key to managing one’s own health.   It will be interesting to watch as taxpayers and the IRS grapple with the tax treatment of digital health platforms moving forward.  In the interim, for a more detailed discussion of the issue, see Dyson and Chittenden, “Is It Time for Deductions of Smartwatch Expenses?”, 164 Tax Notes Federal 203 (July 8, 2019).