May 2002
Volume 66 |
Number 5
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RESIDENTS'
REVIEW
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| FICA Exemption for Residents |
Jill M. Mhyre, M.D. "Resident's Review"
Co-editor
Squeezed between six-figure debt loads and stagnant salaries,
residents around the country have turned to Federal Insurance
Contributions Act (FICA) tax rebates to provide relief. Certain
workers are exempt from paying this tax, and the status of medical
residents has been questioned. If a resident qualifies for an
exemption, the FICA taxes withheld in error could add up to more
than $10,000 for a four-year residency.
FICA is the law that created funding for Social Security and
Medicare through obligatory payroll deductions and matching employer
funds. Currently, the Social Security tax rate for employees is
6.2 percent, and the Medicare tax rate is 1.45 percent –
adding up to the magical 7.65 percent.1 The 7.65-percent employer
match makes for a hefty tax – 15.3 percent of base wages.
Student employees in certain circumstances are exempt from this
tax, however. "Services performed by a student enrolled and
regularly attending classes, providing services for a private
or public school, college or university" are subject to income
tax, but exempt from the Social Security and Medicare program.
The Social Security Act section 410(a)(10) states that if the
person's "main purpose" is pursuing a course of study
rather than earning a livelihood, the person is a "student,"
and the work is not considered "employment."
Social Security was originally conceived as a social insurance
program sponsored by the government to protect workers in private
companies. However, Section 218 of the Social Security Act extended
the program to state government employees through agreements between
the Social Security Administration (SSA) and individual states.
Each "Section 218 Agreement" is different. Some have
explicit clauses excluding students; others have explicitly included
students.
Minnesota's Section 218 Agreement was made in 1955 and excluded
any "services performed by students." In 1958, the state
extended the agreement to "employees" of the University
of Minnesota. At the time, medical residents were considered to
be students, and for the next 30 years, Minnesota did not withhold
or pay FICA on behalf of its residents. In 1989, SSA initiated
an investigation and assessed the university $8 million (15.3
percent) in FICA taxes on the stipends paid to medical residents
for the years 1985 and 1986. The University of Minnesota contested
the assessment in court. In 1997, the district court granted summary
judgment in favor of the State of Minnesota, and in 1998, the
Eighth Circuit Court affirmed the decision.2,3 Certain factors
about the Minnesota program strengthened the claim for student
status. For example, the medical residents were enrolled at the
university, paid student tuition and were registered for coursework
amounting to approximately 15 credit hours per quarter.
The State of Minnesota decision launched a national movement
to submit claims for FICA exemption both by individual residents
and by teaching hospitals. In March 2001, the rush for reimbursement
drove the Internal Revenue Service (IRS) to suspend refund requests
and analyze the claim. A General Accounting Office report in 2000
estimated that the Social Security Trust Fund would lose $3.9
billion over the next 10 years if medical residents were found
to be students under the FICA exemption.4
In July 2000, the IRS responded by publishing Rev. Proc. 98-16.5
They concluded that the "determination of the status of these
employees as students requires examination of the facts and circumstances"
of each case. The memorandum outlined the procedure by which IRS
field officers could determine the legitimacy of a claim. The
first step is to determine who is the common-law employer (especially
in cases where residents rotate to multiple affiliated hospitals).
Second, does the common-law employer meet the definition of a
school, college or university? Third, is the resident working
in a state that does not include students under its Section 218
agreement? Finally, is the resident classified as a "student
who is enrolled, paying tuition and regularly attending classes
at a school, college or university?" Details such as who
controls and evaluates resident care services, what rotations
are included in a residency, how the residents are evaluated and
what forms of didactic experiences a residency program provides
are all critical in proving the claim for FICA exemption.
Many teaching hospitals, including the University of Minnesota,
the University of North Dakota and Beth Israel Deaconess Medical
Center have made formal claims on behalf of all their residents.
Some have been settled, and others are still in dispute.
Other institutions have opted to file a "protective refund
claim," which covers both the institution and its resident
employees for a given year. The U.S. Tax Law Statute of Limitations
for seeking any tax adjustment expires after three years. A protective
refund claim reserves the right to contest past FICA payments
for at least two additional years, while other institutions take
on the expensive and time-consuming task of making formal claims
and pursuing the case in court. If the court cases lead to favorable
judgments, the organizations that filed the protective refund
claim will be able to amend their tax returns and provide the
information necessary to justify the amount of the refund claimed.
Claims filed now will protect taxes paid in the 1999 tax year.
Many programs are not submitting either formal claims or protective
claims. Residents in these programs have the option of seeking
refunds individually using forms 1040X or 843. Since the stricter
IRS analysis was started, however, these individual claims have
been set aside until the larger institutional claims can be processed.
Moreover, if the courts ultimately provide an unfavorable ruling
on this issue, residents who already received their refund could
be subject to repayment with interest and possible penalties.
The tax agency has up to two years to demand the refunds back
if it determines that the student exemption was erroneously granted.
For this reason, residents who receive any money should invest
it wisely for two years before spending any of it.
If your program decides to pursue a protective refund claim,
you will be asked to sign a consent form stating that you will
not pursue the matter on an individual basis as well. This form
is required by the IRS to avoid "competing claims."
It also means that the full 15.3 percent will be paid to the employer,
and the employer should pass half of that back out to its former
employees. If you are filing individually, you also will need
a comparable letter from your employer to avoid competing claims.
Finally, before signing any forms, remember that disability and
survivor benefits are awarded based upon the number of years that
an employee pays FICA taxes. The work requirements start at just
one and one-half years before age 24 but increase biannually,
reaching a 10-year work requirement for those over age 60. Social
Security payments at retirement are based on the 15 years with
the highest salary. For residents who plan to be in training for
many years, for older residents and for residents with chronic
illness and/or family members who would benefit from Social Security
disability or survivor benefits, the cash in hand may not be worth
the risk.6
Expect to wait several years for this issue to be resolved. The
possibility of a refund at some point is much less valuable than
cash in hand during residency. On the other hand, the small time
that it would take to submit an individual claim might pay off
down the line. For more information, and to download copies of
the forms and letters that you will need in order to file individually,
go to < www.webcom
.com/mdtaxes/news0201.html >
References:
1. American College of Physicians–American Society of Internal
Medicine. FICA refunds for housestaff. < www.acponline.org/srf/fica_refunds.htm
>. Accessed on April 3, 2002.
2. McGaw Resident & Fellow Forum. FICA Tax Student Exception
History. < www.mrff.org/fica/history.html
>. Accessed on April 3, 2002.
3. McDermot, Will & Emery. Protective refund claims provide valuable
but inexpensive benefits to hospitals. Health Law Update. 2000;
17(1). < www.mwe.com/news/hlu1701.htm
>. Accessed on April 3, 2002.
4. Greene J. Clarification sought on FICA exemption for residents.
American Medical News. 2002; January 21. < www.ama-assn.org/sci-pubs/amnews/pick_02/prse0121.htm
>. Accessed on April 3, 2002.
5. IRS Rev. Proc. 98-19. < www.ama-assn.org/ama/upload/mm/16/pirsficamemo.pdf
> . Accessed on April 3, 2002.
6. Committee of Interns and Residents. FICA "student exemption"
for residents faces tough scrutiny from IRS. July 2001. < www.cirdocs.org/news/196hoursnewspage.htm
>. Accessed on April 3, 2002.
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Jill
M. Mhyre, M.D., is a CA-2 anesthesiology resident at the University
of Michigan, Ann Arbor, Michigan. |
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