The medical resident FICA issue appeared to be resolved when:
- In 2005, the IRS issued new regulations that appeared to foreclose the application of the “student FICA exception” (Code section 3121(b)(10)) to medical residents on a prospective basis.
- The IRS agreed to honor medical resident FICA refund claims relating to periods prior to the effective date of the new regulations.
- In 2011, the U.S. Supreme Court upheld the validity of the regulations (Mayo Foundation for Medical Education & Research v. United States, 131 S. Ct. 704 (2011)).
In the present case, the University of Texas System attempted a new approach, premised on the state-employee exemption under Code section 3121(b)(7) and the specifics of a “section 218 agreement” (referring to a provision of the Social Security Act) entered into between the State of Texas and the Social Security Administration.
This approach failed its first test, when the U.S. District Court for the Western District of Texas held that the “section 218 agreement” did not exclude wages paid to the university’s medical residents from FICA tax.
Read the federal district court’s order [PDF 1 MB]
Code section 512(b)(7) generally excludes wages paid to state employees from Federal Insurance Contributions Act (FICA) taxes, unless the state has “opted in” to Social Security coverage for its employees via a section 218 agreement with the Commissioner of Social Security.
Generally, wages paid to employees covered by section 218 agreements are subject to FICA, unless excluded under the section 218 agreement.
Texas’s section 218 agreement
Texas’s section 218 agreement excludes from its coverage students who are enrolled and regularly attending classes at the University of Texas (among others).
The University of Texas claimed a refund of FICA taxes paid in 2005 on stipends paid to medical residents at various of the university system’s medical centers on the ground that such medical residents were excluded from the coverage of Texas’s section 218 agreement, and thus were not subject to FICA under section 3121(b)(7).
The university’s position was based on the Eighth Circuit’s decision in Minnesota v. Apfel, 151 F.3d 742 (8th Cir. 1998), requiring a case-by-case analysis of whether medical residents are students for this purpose.
The federal district court held that the operative language of Texas’s section 218 agreement is “virtually identical” to the language in the student FICA exemption in section 3121(b)(10), and that Texas and the Commissioner of Social Security intended to incorporate the student FICA exemption in the section 218 agreement.
Moreover, the court held that Apfel is obsolete. Accordingly, the federal district court found that the definition of “student” in the regulations under section 3121(b)(10) applies in interpreting Texas’s section 218 agreement; and therefore, the 40-hour rule contained in the regulations applies.
The federal district court also explained that medical residents are not students under Social Security rules and regulations. Alternatively, the court noted that, viewing the section 218 agreement as a contract, it evidences no intent to exclude medical residents as “students,” as that term is ordinarily understood, and even if it did, such intent would be contrary to the definition in the subsequent section 3121(b)(10) regulations, which would override the section 218 agreement.
Tax professionals have observed that the federal district court decision could be appealed, and that it is unclear whether other courts would agree with it.
In the meantime, state colleges and universities may need to consider whether, in appropriate circumstances, to file protective claims for refund of FICA taxes paid on stipends paid to medical residents under section 3121(b)(7).
For more information, contact:
Rick Speizman, National Partner-In-Charge, KPMG’s Exempt Organizations Tax Practice (ExoTax)
+1 (202) 533-3084