In a decision announced January 11, 2011, the U.S. Supreme Court rejected a challenge by the Mayo Foundation for Medical Education and Research to the IRS 2005 regulations which effectively classified all medical residents as outside the "student exception" to Federal Insurance Contributions Act (FICA) taxes because they normally perform services 40 or more hours per week. The 8-0 decision (Justice Kagan not participating) authored by Chief Justice Roberts ended more than two decades of litigation relating to appropriate classification of medical residents for the purposes of paying employment taxes imposed by FICA. The decision impacts virtually all academic medical centers and teaching hospitals. While the industry was hopeful, many tax and healthcare professionals who closely monitored the case had anticipated the outcome, particularly after oral argument of the case. The Court briefly reviewed the highlights of the Medical Resident-FICA controversy noting the historical case-by-case determination by the government to applying the student exception, the 1998 decision by the Eighth Circuit Court of Appeals in Minnesota v. Apfel that medical residents could not be categorically excluded from student status under then-existing regulations, that more than 7,000 claims seeking FICA tax refunds were filed and the ultimate Treasury Department determination that "additional regulatory clarification" was needed. These 2005 claims and the litigation they spawned, in which the government had mixed results, lead to the regulations effective April 2005. These regulations were promptly challenged by the Mayo Foundation, seeking a refund of FICA taxes paid for the second quarter of 2005. While the Mayo Foundation was successful at the district court, the court of appeals reversed the district court and upheld the regulations. The U.S. Supreme Court agreed to hear the case and argument was held in November 2010.
The Supreme Court's decision deals extensively with the appropriate legal standard for reviewing agency regulations. After concluding that the plain text of the FICA statute lacked the precision necessary to determine whether medical residents were clearly excluded from the statute's definition of "students," the Court determined that the appropriate standard for review was that articulated in its Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc. decision. The Court had little difficulty or hesitancy in determining that the regulation was a "reasonable interpretation" of the statute. The Court's mandated standard of deference to the government regulation supported the regulatory approach of drawing a bright line "between workers who study and students who work" at 40 hours of required service, concluding that it was "a perfectly sensible way of accomplishing" the distinction. The Court concluded that the Treasury Department's classification of medical residents as the type of workers intended to both contribute to and benefit from the Social Security System was not irrational.
Importantly, while the Court's decision effectively ends any refund claims for the periods after April 2005, the Court's decision had no effect on the IRS March 2010 administrative determination that accepted the position that medical residents were students not subject to FICA tax for the periods prior to the effectiveness of the 2005 regulations. Academic medical centers with refund claims continue to report significant administrative challenges in meeting the IRS requirement to secure the refund for the pre-2005 refund claims.