As noted in the January 6, 2009, McDermott On The Subject entitled “Teaching Hospitals: Resolving Claims Seeking a Refund of FICA Tax on Medical Resident Stipends,” most of the teaching hospitals in the United States have had pending, for almost a decade now, tax refund claims that seek to recover from the Internal Revenue Service (IRS) millions of dollars in Federal Insurance Contributions Act (FICA) tax paid on stipends provided to their medical residents. The pending claims typically reach back to tax quarters in 1995 and address both the employer’s and the employees’ shares of FICA. The IRS has refused to take any administrative action on the claims—refusing to allow, disallow or settle them.
Institutions that wish to file refund claims for FICA taxes paid for quarters in the calendar year 2005 must file such claims with the IRS by April 15, 2009, to avoid the bar of the statute of limitations. As this deadline for another filing year approaches, a brief description of the status of these claims is below.
A few teaching hospitals brought suit in federal courts, on behalf of themselves and their residents, to recover tax refunds, while the government brought suit against a few teaching hospitals that had managed to obtain refunds. In 2005 and 2006, the IRS won four decisions before federal district court judges, starting with a victory in Miami. Since then, however, taxpayers have racked up a very impressive string of victories. Of the last 15 substantive decisions issued by the federal courts, 12 have gone in favor of the teaching hospitals, including victories on the Student Exception (IRC § 3121(b)(10)) issue in the U.S. Courts of Appeals for the Seventh and Eleventh Circuits–and very recent victories in the Sixth and the Second (for more information, see “Recovering FICA Tax Paid on Resident Stipends Time for a Strategic Review.” Importantly, all of the IRS-favorable decisions rendered in the lower federal courts in 2005 and 2006 have now been reversed by the circuit courts of appeals.
Despite these victories by teaching hospitals, there is no indication that the IRS is prepared to fully or partially concede this large-revenue issue, although the U.S. Department of Justice (DOJ) (as opposed to the IRS) has recently shown a willingness to settle, on a case-by-case basis, some of the cases that taxpayers bring to court for quarters before the second quarter of 2005.
As to FICA tax paid for the second, third and fourth quarters of 2005, and all quarters for subsequent years, a serious question exists concerning the validity of a regulation issued by the Treasury Department in 2005 that purports to place the Student Exception from FICA categorically off limits to medical residents. But twice now, a federal district judge in Minnesota has held the regulation invalid. Thus, teaching hospitals should seriously consider filing claims for refund for all quarters in 2005 and subsequent quarters–notwithstanding the Treasury Department’s 2005 regulation. Neither IRS nor DOJ is expected to settle, within the foreseeable future, cases focusing upon quarters addressed by the 2005 regulation.
There are several new procedural aspects to filing claims for refund of FICA tax paid for 2005 and subsequent years. First, claims for refund of FICA tax now have to be made separately for each quarter on the new IRS Forms 941x, Adjusted Employer’s QUARTERLY Federal Tax Return of Claim for Refund. These claims formerly were made on an IRS Form 843, Claim for Refund or Abatement, a form that was in use for decades. Unfortunately, the new Form 941x is not well drafted and requires the insertion of qualifiers. Second, claims filed for all quarters after the first quarter of 2005 should expressly include a challenge to the validity of the 2005 regulation, if the taxpayer wishes to obtain a result similar to that obtained in the two cases decided by a federal district judge in Minnesota. Third, a return preparer with respect to a Form 941x that seeks a refund in the face of the 2005 regulation should submit a completed Form 8275-R, Regulation Disclosure Statement, with the Form 941x.
Matters of a more substantive nature also need to be addressed in this set of claims. For example, whether the Form 941x should be filed as a “protective” claim (i.e., an incomplete or contingent claim that is filed to meet the requirements of the limitations statute and that requests that the IRS refrain from taking action on the claim) or as a “regular” claim is an issue that should be discussed with tax-litigation counsel experienced in this area.
Beyond the immediate task of preparing and filing tax-refund claims for quarters in 2005 and subsequent years, teaching hospitals would be well advised to undertake a review of whether the “protective” claims filed to protect the limitations statute often filed over the years for years before 2005 should be supplemented with additional information to “perfect” them, and whether, strategically, the time has come to move forward into court to obtain a recovery, either by an in-court settlement with the DOJ or by money judgment. Again, review of these issues should be undertaken with tax-litigation counsel experienced in dealing with DOJ in the litigation of these types of cases.