Law

FICA taxes must be paid on all wages. As defined in IRC §3101 & §3121, wages are all remuneration for employment. The term “employment” is broadly defined by the statute as any services performed by an employee for an employer. There are specific exceptions to these rules listed in the statute. IRC §3121(b)(10) excepts services performed in the employ of a school, college, or university or affiliated organization described in §509(a)(3), if the services are performed by a student who is enrolled and regularly attending classes at that school, college or university. Under the existing regulations, the term “school, college or university” is to be taken in its commonly used or generally accepted sense. To qualify as a “student performing services” the individual must be pursuing a course of study and his status determined on the basis of the relationship of the employee with the school.

Minnesota v. Apfel

The case that opened a floodgate of FICA refund requests was a decision by the Eighth Circuit Court of Appeals in State of Minnesota v. Apfel. The University of Minnesota had not paid social security tax on stipends paid to medical residents enrolled in the graduate medical education program. The State of Minnesota had an agreement in effect (Section 418 agreement) since 1958 in which it specified group that were to be covered by Social security. The agreement specifically excluded “any service performed by a student” from FICA. The Social Security Administration sought to treat the stipends paid to medical residents as subject to FICA.

The district court ruled that (1) the medical residents were not “employees” of the University as used in the Section 418 agreement and that the state did not intend to extend coverage to the medical residents; and (2) Even is the medical residents were considered “employees” under the terms of the agreement, they would be excluded under the student exclusion. The courts found that the primary purpose of the medical resident’s relationship with the University was to pursue a course of study and not to earn a livelihood and were therefore students. The Court of Appeals affirmed the district court’s decision. A unique fact in this case is the Section 418 agreement that sought to include certain state employees in the Social Security system.

U.S. v. Mayo Foundation for Medical Education and Research and Mayo Foundation

Mayo Foundation applied for a refund of FICA taxes paid on Medical residents for the years 1994 – 1996. Mayo received a refund of the 1995 amounts. In 2003, the Government sued to recover the refund as an erroneous refund. The cased centered on whether the medical residents were “students” and whether the stipends were received from an organization that qualified as a “school, college or university” within the meaning of §3121(b)(10).

The Government argues that as a matter of law the student exception could not apply to medical residents. It cited the repeal of the exemption for interns as basis for its argument, saying that Congress did not intend for the student exemption to apply to interns or others in similar situations. The Court rejected the argument because it would create a “bright-line” test instead of the required case-by-case facts and circumstances analysis as set forth in the current statue and regulations.

Mayo Foundation did have the burden of proof to show that its medical residents met the student FICA exception within the meaning of §3121(b). The case focused on the nature of the medical resident’s relationship with the Mayo Graduate School of Medicine, an unincorporated division of the Mayo Foundation. The primary purpose of the relationship must be to pursue a course of study. Mayo had to prove that: (1) the medical residents were employed, (2) the employer was a school, college, or university, and (3) the medical residents were students.

In determining if the residents were “employed” by the Foundation, the court looked to the common law employer-employee relationship as discussed in the Treasury Regulations. Under these regulations, an employer-employee relationship exists if the person for whom services are performed has the right to control and direct the individual who performs the service, including the details and means by which the work is accomplished. The right to hire or discharge an individual is also evidence of the employee-employer relationship. (Treas. Reg. §31.3121(d)-1(c)).

The Government argued that the Mayo clinics (physical location where patient services were performed) were the employer. However, the clinics did not have the ability to control or direct the residents. That right was held by the MGSM. Thus, the court ruled that the Foundation was the employer of the medical residents.

Once the employer was determined, the court looked to see if the employer qualified as a school, college, or university. The regulations under §3121 state that the term “school, college, or university” is to be taken in its generally accepted sense. The government, in arguing this case, wanted to use a primary purpose test, i.e. that the organization was classified as a school, college, or university under IRC §170(b)(1)(A)(ii). The court held that if it was the intent to use a primary purpose test, then a cross reference to the §170 definition would have been listed in the Regulation. The court rejected the governments argument and ruled that the Foundation was a “school, college, or university” within the meaning of §3121(b)(10).

The last test was whether or not the medical residents met the definition of “student” for purposes of the exception. The statutory tests is whether the individual is enrolled and regularly attending classes at the “school” employed and if the services are incident to and for the purpose of pursuing a course of study. Clearly, the medical residents were enrolled in the residency program at MGSM. In the program, the residents were required to attend conferences, lectures and teaching rounds. This attendance was mandatory for all residents. All were routinely scheduled throughout the week.

The government argued that the court should use a minimum attendance in pursuit of a degree requirement. The court rejected this argument, stating that the regulations only require pursuing a course of study and that every course of study might not and need not lead to a degree. The court also held that the patient care services provided by the medical residents was incidental to the primary purpose of pursuing a course of study in medicine.

Proposed Amendments to Regulations & Revenue Procedure

The IRS has proposed amendments to Treasury Regulations §31.3121(b)(2)-1, §31.3121(b)(10)-2, §31.3306(c)(10)-2, and has issued a proposed Revenue Procedure (see Notice 2004-12) to make changes within the student FICA exemption. It is evident from reading the court opinions in the University of Minnesota and Mayo and the proposed regulations and revenue ruling that the IRS set out to specifically address the issues brought out in the court rulings.

In the proposed rules, the IRS set out to specifically define and use the terms that were not defined in the earlier rules. For example, the proposed rules define “school, college, or university” to mean an organization “if its primary function is the presentation of formal instruction, it normally maintains a regular faculty and curriculum, and it normally has a regularly enrolled body of students in attendance at the place where its educational activities are regularly carried on.” A cross reference to §170(b)(1)(A)(ii) and is regulations is also included.

The regulations define “course of study” as “one or more courses ...which fulfills the requirements necessary to receive an educational credential granted by a school, college, or university…” Educational credential is also defined as a “degree, certificate, or other recognized educational credential” and can also include fulfilling the requirement to sit for a certification examination.

In addition, the regulations state that a career employee cannot qualify for the student exception to FICA. The regulations provide definitions and examples of career employees including employees eligible to:

receive vacation, sick leave, or paid holiday benefits, participate in a retirement plan,
receive employee benefits under sections 79, 127, 129, or 137, or
classified by the employer as a career employee.

The proposed revenue procedure follows these same rules and suspends Revenue Procedure 98-16. The proposed procedure updates the safe harbor of Rev. Proc. 98-16 and provides for the following:

Adds a primary function requirement to the definition of “school, college, or university”,
Does not permit the student FICA exception to employee who regularly works 40 or more hours per week,
Classifies any “professional employee” as a career employee,
Expands the terms of employment that result in career employee,
Classifies any individual required to be licensed to perform the services as a career employee.

Both the proposed regulations and the proposed revenue procedure are effective for services performed on or after February 25, 2004. The IRS has made it more difficult for medical residents to qualify for the student FICA exception. There is some window of opportunity to file a refund claim for FICA taxes paid for services prior to February 25, 2004 if an organization and its medical residents have similar factual situations to those presented in the Mayo case. Those organizations (if any) whose medical residents can meet the requirements of the new rules may also want to file refund claims for FICA taxes paid as well as stop withholding and paying FICA on current medical residents that can qualify.