The FICA debate rages on, and the IRS keeps losing. Even so, the IRS appears to be in no hurry to return any FICA taxes to medical residents and their residency programs.

We originally wrote about medical residents being exempt from FICA taxes back in our February, 2001 newsletter (available at www.mdtaxes.com/news0201.html). Since the basic rules have not changed since then, here is what we wrote back in 2001:

There is some ambiguity in the tax laws as they apply to medical residents being classified as employees or students. The rule in question deals with people who are employed by colleges, universities, and organizations (such as teaching hospitals) affiliated with colleges and universities. According to IRS code section 3121(b)(10), employees of universities and their affiliated entities need to be classified as either "student employees" or "career employees".

Employees classified as student employees are exempt from paying social security and Medicare taxes on money earned while employed at the school. This rule was most likely put in place to help students better afford their tuition and living expenses while enrolled in either an undergraduate or graduate program. (Social security and Medicare taxes are currently withheld at a rate of 7.65% of your gross salary.)

In the court case dating back to before 2001, the University of Minnesota was not withholding social security taxes from their medical residents claiming, instead, that the residents should be treated as student employees. The IRS assessed the university more than $8 million in unpaid Social Security taxes. The university took the IRS to court and won both the court case and the subsequent appeal, opening the door for medical residents to be classified as student employees instead of career employees, and in theory, allowing the residents to receive refunds of social security and Medicare taxes withheld from their pay.

Recent Activity In The Courts:

According to CPElite, Inc, a provider of continuing education for tax preparers, on page 10 of their Elite Quarterly publication for the Winter, 2008, the IRS recently lost a FICA case against the Center for Family Medicine and University of South Dakota School of Medicine Residency Corporation. The courts sided with the residency program because of the following facts and circumstances:

1. The residency programs were responsible for interviewing and hiring the residents via the match program.

2. The contract was written between the incoming residents and the residency programs.

3. The residency programs required each resident to complete specific rotations, and the physicians who supervised the residents were members of the program's faculty.

4. The residency programs had the primary authority to discipline the residents, and ultimately, determined the residents' ability to advance.

Prior to this case being decided, the IRS had asked the courts for a summary judgment to dismiss this case. Check out the CENTER FOR FAMILY MEDICINE, a South Dakota Corporation, and the UNIVERSITY OF SOUTH DAKOTA SCHOOL OF MEDICINE RESIDENCY CORPORATION, a South Dakota Corporation, Plaintiffs, vs. UNITED STATES OF AMERICA Defendant.

For their main argument in the summary judgment, the IRS referred to a "Bright Line Rule" which states that medical residents never qualify for the "student exemption", and therefore, are never exempt from the FICA tax. The court ruled against the IRS, and held that "the determination of whether plaintiffs’ medical residents are 'students' requires a case-by-case inquiry into the relationship between plaintiffs and their medical residents."

In another case involving the Mount Sinai Medical Center of Florida, Inc., the Court of Appeal for the 11th circuit held that the district court erred in ruling that medical residents enrolled in graduate medical education programs are precluded, as a matter of law, from seeking to rely on the student exemption to FICA taxation, and issued the district court to "VACATE the summary judgment and REMAND for further proceedings consistent with this opinion."

Let's Work Together:

Let's work together to keep current on this hugely valuable tax break. We've set up a new Message Board just for this topic available at www.mdtaxes.com. Please remember to post whatever you hear or read regarding this FICA issue on our new forum.

To borrow the campaign slogan from current Massachusetts Governor Deval Patrick, "Together We Can."

Andrew Schwartz CPA is a partner in the Woburn, MA CPA firm, Schwartz & Schwartz, PC, a firm specializing in the tax issues affecting healthcare professionals and their practices. Andrew is also the founder of The MDTAXES Network (www.mdtaxes.com), an association of CPAs who specializes in the tax issues affecting doctors and their practices.