On September 23, 2008, the United States Court of Appeals for the Seventh Circuit held that medical residents may qualify for the student exception from the payment of taxes under the Federal Insurance Contribution Act (FICA) and that the determination of whether a medical resident qualifies for the student exception is to be made on a case-by-case basis.
FICA taxes are imposed to support the social security system and are levied on wages paid by employers to employees. “Employment” is broadly defined, but it excludes services in the employ of a school, college, or university, or of certain organizations organized and operated, or to carry out the purposes of a school, college, or university, if the services are performed by a student who is enrolled in and regularly attends classes at such institution. This exception is generally referred to as the “student exception”.
The University of Chicago Hospitals (UCH) sought a refund of FICA taxes it paid in 1995 and 1996 with respect to wages paid to medical residents on the basis that the residents qualified for the student exception. The IRS took no action on the refund claim and UCH subsequently filed a refund suit in District Court. The government argued that medical residents were not students and therefore ineligible for the student exception. The District Court rejected the government’s motion and the government appealed to the Seventh Circuit of Court of Appeals.
The government argued on appeal that medical residents are ineligible for the student exception because (1) having already received a medical degree, medical residents are not students, and (2) a hospital is not a school, college or university in the common sense of the words. The court disagreed and found that a teaching hospital may indeed be considered as part of an affiliated university and that a medical resident may be regarded as a student even though he or she has received a medical degree. The court further noted there is nothing in the statute that categorically excludes medical residents from eligibility for the student exception. The court therefore held that the student exception is not per se inapplicable to medical residents, but rather the applicability of the exception is to be determined on a case-by-case basis.
It is important to note that effective April 1, 2005, the IRS amended the Treasury Regulations applicable to the student exception in various ways that would appear to exclude medical residents from the student exception. For example, the amended regulations provide that an organization qualifies as a school, college or university if its primary function is formal instruction, it normally maintains a regular faculty and curriculum, and it normally has a regular enrolled body of students. The amended regulations further provide that an employee is a student if the services the employee performs are incident to and for the purposes of pursuing a course of study, and an employee whose normal work schedule is at least 40 hours per week is considered to be a full time employee and not a student because the services performed by the employee are not incident to and for the purpose of pursuing a course of study. The amended regulations also provide that if an employee is a licensed, “professional” employee (as defined in the regulations), that suggests that the service aspect of the employee’s relationship with the employer is predominant.
However, in Mayo Foundation for Medical Education and Research v. United States, 503 F.Supp. 2d 1164 (D. Minn. 2007), the District Court of Minnesota ruled that the amended regulations are invalid because they are unreasonable and inconsistent with the plain meaning of the statute they are intended to interpret. The IRS has appealed the District Court’s decision to the Eighth Circuit Court of Appeals.
In light of University of Chicago Hospitals, hospitals should consider filing claims for refunds of FICA taxes on wages paid to their medical residents, especially for FICA taxes paid before April 1, 2005. Although the amended regulations appear to preclude a refund for any FICA taxes paid after April 1, 2005, as previously discussed, at least one court has found the amended regulations to be invalid. Therefore, although the law is not settled, hospitals should consider filing claims for refunds.