For ResidentsTax refunds for residents? The issue heats up again
Teaching hospitals say residents are exempt from certain taxes, but a new IRS memo may not agree
From the November 2000 ACP-ASIM Observer, copyright © 2000 by the American College of Physicians-American Society of Internal Medicine.
By Christine Kuehn Kelly
Nearly two years ago, residents at the University of Minnesota received what might be considered the equivalent of winning the lottery. The courts ruled that because housestaff at the University of Minnesota's training programs are students and not employees, they don't have to pay Medicare and Social Security taxes. The happy result was thousands of dollars in individual refunds for current and some past residents, plus an end to the taxes for current housestaff.
The verdict created a stir among teaching hospitals, and more than 200 training institutions filed for refunds of the taxes, which were created by the Federal Insurance Contributions Act (FICA). Resident refunds got even more attention earlier this year, when the IRS released a memo exploring whether housestaff are students or employees and should have to pay FICA taxes. All the attention has left many residents wondering if they can expect a refund from the IRS and when they will stop paying FICA taxes.
The word from tax experts, however, is that residents shouldn't expect any big change in their tax situation in the near future. They say that the Minnesota decision is not a good precedent for other training programs because the state university there is atypical. And the recent memo from the IRS, they say, may not give teaching hospitals much help fighting FICA taxes for residents.
"We tell our institutional clients that while there is merit in the claims they are filing, the likelihood of success is minimal," said David Fuller, a former IRS official who worked on the issue and is now a tax attorney in the Washington accounting firm of McDermott, Will and Emery. "The IRS and the Social Security Administration intend to aggressively challenge new claims based on the Minnesota ruling."
Most tax experts say that the Minnesota ruling is a weak precedent because residency programs at the University of Minnesota differ from typical programs. University of Minnesota postgraduates, for example, register for courses and pay tuition.
And because the university is a state institution, it can legally exempt students from Social Security coverage. As a result, students in states like Minnesota where residents working at state or local institutions are exempt from Social Security coverage are also exempt from FICA taxes. The university's success in court hinged largely on the fact that residents and students should not pay taxes for a benefit they do not receive.
The Minnesota decision also has limited applicability because it was decided in the 8th U.S. circuit court of appeals, which has jurisdiction over just seven states: Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota.
This year's memo from the IRS, tax experts say, may not give teaching hospitals much more to go on. The memo sets forth several key tests to help IRS agents determine the validity of teaching hospitals' claims that their residents are exempt from FICA taxes. None of the following tests are going to be easy to meet:
- Are residents students?
Federal tax laws generally exclude student workers from paying FICA taxes. Residents, however, can be viewed as employees rather than students of their institutions.
Mary Oppenheimer, IRS assistant chief counsel, whose office prepared the memo, pointed out that almost every resident program has learning objectives that are part of a curriculum. The key, she said, is how well a resident's daily activities fit into that curriculum and its objectives.
For example, are rounds for educational purposes or for ensuring adequate patient care? The Accreditation Council for Graduate Medical Education, which oversees training programs, distinguishes between "teaching rounds" intended for educational purposes and "work rounds," which are primarily for patient care, Ms. Oppenheimer pointed out. She said IRS agents will want to know how the day-to-day activities of housestaff are similar to those of students and other hospital staff.
- Who's the employer?
The institution that signs your check may not necessarily be your "common law employer" in the eyes of the IRS. A common law employer has the right to direct, control and evaluate your work. The IRS also looks at who benefits financially from your services, who is legally liable for your mistakes on the job, who controls how you perform specific tasks and who provides employee benefits like malpractice insurance. Defining a resident's employer could be even more complicated because of the rotations that most housestaff serve at other institutions. The IRS appears to favor viewing the facility where residents serve a rotation, not the training program, as the employer during those months.
- Is the employer a school?
The student FICA exception applies only if a resident's common law employer is an educational institution. "This has to be true for there to be even a possibility of a refund," said Ms. Oppenheimer. While teaching hospitals have argued that they should be treated as schools for this purpose, it is not clear how the IRS will respond.
- Are residents covered by Social Security?
In the Minnesota case, residents were not covered. Under what is known as a "section 218 agreement," state and local governments can extend Social Security coverage to government workers, such as employees at state university hospitals. These employers, however, can also decide not to extend those benefits to student workers, as was the case in Minnesota.
Another issue that may affect the debate over residents and FICA taxes is a recent ruling on whether housestaff can unionize. In 1999, the National Labor Relations Board (NLRB) ruled that because residents effectively function as employees, they can unionize. If one part of the federal government defines residents as employee-students, can they remain student-employees in the eyes of the IRS?
The IRS cites the NLRB ruling in its memo and says that the description of residents' daily activities and responsibilities in that decision "makes it difficult to characterize residents' activities as primarily for the purpose of pursuing a course of study." Some analysts, however, say that such an interpretation is not correct.
"It's a labor decision, not a tax-law decision," said Rick Speizman, a tax partner in the Washington office of KPMG, an international accounting firm. "The NLRB's decision specifically states that the status of medical residents as students is not mutually exclusive of their also being employees."
Teaching hospitals' reaction
While the recent IRS memo may not give teaching hospitals the ammunition they had hoped for, analysts insist that the situation is far from bleak. "If the IRS doesn't initially agree with you," Mr. Speizman said, "it doesn't automatically mean that you are wrong." The IRS position is not law, but it does affect how its agents handle cases.
Teaching hospitals are not giving up, in part because they have a vested interest in winning a FICA exemption for their residents. For every dollar that they deduct from residents' paychecks for FICA taxes, teaching hospitals must also pay a dollar. (Residents pay 7.65% of their income into these taxes.) An exemption for housestaff, then, would potentially free up more money for teaching.
Some teaching hospitals say they are taking a wait-and-see attitude. "We backed off to see where the process is leading," explained Tom Hackl, residency program administrator at the Medical College of Wisconsin. "We are waiting for another claim to come through to serve as a test."
One institution that asked to remain anonymous already filed for FICA refunds earlier this year. Officials say that because their organization houses both the university and the medical center where residents do most or all of their rotations, they believe they have a good chance of success with the IRS.
Still other teaching hospitals are taking a different approach and filing what is known as a "protective refund claim." This strategy stops the clock on the three-year statute of limitations for requests. If the IRS eventually rules that housestaff are exempt from FICA taxes, teaching institutions that filed this type of claim may be entitled to a refund on taxes even if more than three years have lapsed.
What can residents do to protect their interests while the issue is being thrashed out? You can file a refund claim yourself, but experts say that it is an extremely expensive and time-consuming process. Instead, they say, work with your teaching hospital.
"Encourage your institution to file an inexpensive protective refund claim," said Mr. Fuller of McDermott, Will and Emery. "This preserves the refund rights of both the hospital and the residents until the issue is litigated in the courts or further favorable IRS guidance is issued."
Mr. Fuller said he also tells residents that many hospitals aren't filing claims, "So don't necessarily expect yours to be seeking the refund." Finally, even if an institution receives a refund, tax experts say, the IRS has two years to change its mind, so don't have high expectations of ever receiving a refund. But after you leave your program, keep in touch--just in case.
Christine Kuehn Kelly is a Philadelphia-based freelance writer specializing in health care.
According to Charles Solcher, manager of the University of Texas graduate tax program, IMGs are considered nonresident aliens who are here under a J-1 visa and are not subject to Federal Insurance Contributions Act (FICA) taxes for the first five years in the United States.
This means they should not have FICA taxes taken out of their stipends. "But some employers don't make a distinction between IMGs and other employees," Mr. Solcher pointed out. If FICA taxes are being withheld from your stipend, talk to your program director.
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