Medical FICA Tax Problem Resolution

District court holds that stipends paid to medical residents were exempt from FICA

Regents of the University of Minnesota v. U.S. (DC MN 4/1/2008) 101 AFTR 2d ¶ 2008-647

Mike Habib, EA

A district court has held that stipends paid by the Regents of the University of Minnesota to medical residents were exempt from FICA under the Code Sec. 3121(b)(10) student exception. The court followed the district court’s previous holding in Mayo Foundation, which invalidated IRS regs that would have disqualified medical residents for the student exception.

    Observation: The case has important ramifications for the many teaching hospitals and their residents.
    Caution: The decision doesn’t affect the income tax aspects of medical residents’ stipends. It is well settled that they are not excludible.

FICA background. Code Sec. 3121(b)(10) exempts from FICA service performed in the employ of a school, college, or university “if such service is performed by a student who is regularly enrolled and regularly attending classes at” such an institution. In 2003, in determining that residents in graduate-level medical programs were students entitled to the student FICA exception, a Minnesota district court held, in U.S. v. Mayo Foundation for Medical Education & Research, (2003, DC MN) 92 AFTR 2d 2003-5774, that the residents satisfied these requirements and their wages were not subject to FICA.

In response, late in 2004, IRS amended the regs in this area. The regs now provide that an institution is a school, college, or university only if its primary function is formal instruction; it has a regular faculty and curriculum; and it has a regularly enrolled student body. (Reg. § 31.3121(b)(10)-2(c)) An employee is a student only if the services he or she provides are incidental to the course of study, and if the educational aspect of the relationship predominates over the service aspect. Moreover, an employee whose normal work schedule is 40 hours or more per week is considered a full-time employee and therefore services performed by that individual are not incidental to the course of study. (Reg. § 31.3121(b)(10)-2(d))

In 2007, a district court in Minnesota, finding that the 2004 regs were invalid, held that stipends paid by the Mayo Foundation to medical residents were exempt from FICA under the Code Sec. 3121(b)(10) student exception. (Mayo Foundation for Medical Education and Research v. U.S., (DC MN 8/3/2007) 100 AFTR 2d 2007-5449

Facts. Regents of the University of Minnesota (University) operates graduate medical education programs for medical residents and fellows (collectively, residents). A medical resident is an individual who has earned a medical degree and is participating in a residency program for additional medical training in a specialty field, such as internal medicine or surgery. University entered into affiliation agreements with certain hospitals in Minnesota for the purpose of providing educational experiences to the residents. University paid a stipend to the residents to provide a minimum level of financial support during their enrollment.

Under the affiliation agreements, University had responsibility for the general educational experience of the residents, including: (1) determining educational goals; (2) establishing prerequisite criteria for placement; (3) determining completion of assignments; (4) evaluating the residents’ performance; and (5) selecting and appointing staff members at the affiliated hospital to the faculty of the University for the purpose of training the residents. Staff physicians appointed to the University faculty had the responsibility for teaching, supervising, and evaluating the performance of residents.

University initially paid FICA taxes on the residents’ stipends, but then sought a refund based on the residents qualifying for the FICA student exception.

Student exemption applies to residency stipends. In a summary judgment motion, the district court found that stipends paid by University to medical residents were exempt from FICA under Code Sec. 3121(b)(10). Relying on the previous district court’s determination that the regs were invalid, the district court determined if University qualified for the FICA student exclusion by analyzing whether the residents were: (1) “employed” by University; and (2) “students” who “regularly attended classes.”

The district court found that the residents’ services were performed in the “employ” of University. The physicians involved in University’s residency program held faculty appointments and acted as University’s agent in the administration of the program. Residents learned how to care for patients under the supervision and control of the University-faculty physicians.

However, the court found the residents, who paid tuition which was deducted from the residents’ paychecks, were clearly enrolled at University. The court rejected IRS’s contention that residents were not students who regularly attended classes, but were physicians who worked in hospitals. The educational aspect of University’s residency program necessarily included learning how to safely care for patients. Thus, the principal classroom for residents had to be the clinical setting because they learned by caring for patients in a medical specialty under the supervision of a University-faculty member.

The district court similarly rejected IRS’s claim that the residents’ services were not “incident to and for the purpose of pursuing a course of study” because the hospitals paid the residents to work long hours taking care of patients and the residents provided patient-care services when education was minimal or nonexistent. Instead, the court concluded that the primary purpose of University’s residency program was educational. It found that residents spent the majority of their time learning how to care for patients under the watchful eye of a faculty physician.

    Observation: The only Appellate Court to say that medical residents may qualify for the student FICA exception has been the Eleventh Circuit in a decision which involved years before the 2004 regs went into effect. (U.S. v. Mount Sinai, (CA 11 05/18/2007) 99 AFTR 2d 2007-983 ) The Eighth Circuit Court of Appeals, to which Regents of the University of Minnesota would be appealable, in analyzing a parallel Social Security regulation, found that a case-by-case approach was required to determine whether particular services qualified for the student exemption. (Minnesota v. Apfel, (CA 8 1998) 151 F.3d 742, 747-48)

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