Background on the Issue of
FICA, Residents, and IRS Refunds
1998: Decision by the U.S. Circuit Court of Appeals for
the 8th Circuit
A 1998 decision by the U.S. Court of Appeal for the 8th
Circuit determined that residents at the University of Minnesota
are students and therefore no FICA needs to be paid on their
behalf. The facts at the University of Minnesota are that
for over 30 years the university did not withhold Social
Security contributions from medical residents' stipends,
nor did it pay the employer's share. This is consistent
with University's belief that residents are students and
are not covered by the agreement entered into with the federal
government regarding who is covered by Social Security.
In 1990, the SSA claimed the state owed nearly $8 million
in unpaid Social Security contributions for medical residents
in 1985 and 1986. The university challenged this position
in court. The appeals court found for the university. It
wrote that:
[t]he undisputed facts make it clear, however, that the
primary purpose for the resident's participation in the
program is to pursue a course of study rather than to earn
a livelihood . . . The residents are enrolled at the University,
pay tuition, and are registered for approximately fifteen
credit hours per semester. Although they provide patient
services while working at the hospital, it does not follow
that they are enrolled primarily to earn a livelihood.
The court also noted that it is necessary to make "a
case-by-case examination to determine if an individual's relationship
with a school is primarily for education purposes or primarily
to earn a living. The Commissioner cannot avoid such a case-by-case
examination by summarily concluding that medical residents
are never students regardless of the nature of their relationship
with their employer." The Mayo Foundation, also located
in the 8th circuit, won a simular case against the IRS in
2003.
Following the Minnesota decision, many institutions filed
claims for refunds. In response to those claims, the IRS published
two General Counsel Memoranda, one in April 2000 and one in
November 2001. Under IRS analysis two issues are of most importance.
The first is that the medical resident must be a student.
This requires that the resident be "employed" by
a school, college, or university (S/C/U). The IRS concedes
that a medical school qualifies as a S/C/U, but since much
of the training during medical residency occurs at a hospital,
the second issue is whether a hospital can qualify as a S/C/U.
Underlying the various legal arguments is the fact that the
Social Security Administration estimates a $3.9 billion loss
to the trust fund over 10 years if medical residents are found
to be students.
On February 25, 2004, the Internal Revenue Service issued
a
notice of proposed rulemaking and notice of a public hearing
(69 Federal Register 8604) regarding the issue of the payment
of FICA taxes by medical residents. Comments, either electronic
or written, must be received by May 25, 2004. They should
be sent to: CC:PA:LPD:PR (REG-156421-03), room 5703, Internal
Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. Electronic submissions can sent to the IRS at www.irs.gov/regs.
The rule would apply to services performed on or after February
25, 2004.
Current Law
Under current tax law, services performed in the employ of
a school, college, or university (SCU), or an affiliated organization
are excepted from the definition of "employment" if they are
performed by a student who is enrolled and regularly attending
classes at the SCU. This is popularly known as the "student
FICA exception. " The exception only applies to services if
both the SCU status and the student status requirements, as
set out in IRS regulations, are met.
SCU Status
The IRS acknowledges that in United States v. Mayo Foundation—the
case in which Mayo won its challenge of the IRS’s denial of
the student exemption for residents --the U.S. Court of Appeals
for the 8th Circuit rejected the government’s argument that
hospitals are not SCUs. Nonetheless, in this proposed regulation
the IRS contends that to qualify as a SCU, "it is not enough
that the organization carries on educational activities; instead,
the organization’s primary function must be to carry on educational
activities." The IRS further states that "in common parlance,
the term "hospital" is used to describe an organization with
the primary function of caring for patients." The preamble
contains no discussion of distinctions between the functions
of teaching and non-teaching hospitals, and whether this conclusion
should apply to teaching hospitals.
Based on the IRS SCU analysis, the first prong of the student
FICA exception is not met for residents who receive their
stipend directly from a hospital. However, many residents
receive their stipends from a medical school or university,
either of which could be considered a SCU by the IRS. Nonetheless,
to qualify for the student FICA exception, these residents
must meet the second prong of the test and be considered to
have student status as defined in the tax code.
Student Status
To have student status, the IRS propses that three criteria
must be met:
-
The individual must be enrolled and regularly attending
classes at a SCU. A class involves instructional activities
and is led by a knowledgeable faculty member following
an established curriculum for identified students.
-
An individual must be pursuing a course of study that
fulfills the requirements to receive an educational credential
(i.e., degree, certificate, or other recognized education
credential) granted by the SCU.
-
A determination must be made as to whether the individual's
services are incident to and for the purpose of pursuing
a course of study. Course workload is used to measure
the scope of the educational aspect of the relationship
between the "employer" and the individual. For each case,
a facts and circumstances determination is made as to
whether the education or service aspect predominates.
However, if an individual is found to be a "career employee," then
the service aspect is predominant and the individual
cannot qualify for the student FICA exception.
The IRS is proposing that the following factors
be used to determine whether an individual is a "career
employee:"
- A career employee regularly performs services more than
40 hours per week.
- A "professional employee" is a "career employee." Under
IRS regulations, a professional employee is an employee whose:
(i) primary duty consists of the performance of services requiring
knowledge of an advanced type in a field of science or learning,
(ii) work requires the consistent exercise of discretion and
judgment in its performance, and (iii) work is predominantly
intellectual and varied in character.
- Terms of employment may also trigger the status of a career
employee. These include eligibility to receive vacation, sick
leave, or paid holidays, and participation in retirement plans
or tuition reduction arrangements.
- An employee who must be licensed by a government entity
in order to perform certain functions has the status of a
career employee. The IRS notes "licensed workers typically
earn more than a modest amount for their work to reflect their
expertise."
The AAMC submitted a comment
letter objecting to the IRS proposal. No final rule has
yet been issued.
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