Resolving a circuit split and applying the Chevron standard of greater deference to Treasury regulations, the U.S. Supreme Court upheld the validity of Treasury regulations requiring full-time medical residents and their university employers to pay FICA tax. In doing so, the court announced that tax regulations should generally be accorded Chevron deference.
The case, Mayo Foundation v. U.S., hinged on whether medical residents are exempt from FICA under IRC § 3121(b)(10), the so-called student exception. The provision exempts wages for services performed for a school, college or university if the service is performed by a student who is enrolled and regularly attends classes at the school, college or university. In a unanimous decision written by Chief Justice John Roberts, the court affirmed a 2009 Eighth Circuit decision (568 F.3d 675; see previous Tax Matters coverage, Sept. 2009, page 77) that medical residents working 40 or more hours a week are not eligible for the exception. The Supreme Court’s holding overrules decisions of the Second, Sixth, Seventh and Eleventh circuits, which have called for a case-by-case analysis to determine if residents are considered students and if the hospitals they work for are considered schools, colleges or universities (see “Tax Matters: FICA for Medical Residents Splits Circuits,” JofA, Jan. 2008, page 73).
The Mayo Foundation offers medical residency programs that provide hands-on education in specialty fields to medical school graduates. The residents typically work between 50 and 80 hours per week, during which they examine and diagnose patients, prescribe medication and perform certain procedures under the direct supervision of attending physicians. Residents are also required to fulfill more formal elements of education, such as completing reading assignments and taking examinations. The Mayo Foundation paid the residents stipends and provided them with health and malpractice insurance.
In 2003, the U.S. District Court for the District of Minnesota held that the stipends the Mayo Foundation paid to its residents were not subject to FICA because the residents satisfied the student exception under regulations then in effect (282 F.Supp. 2d 997). Those regulations stated that an employee would be considered a student if the services performed were incident to and for the purpose of pursuing an education at the school, college or university. However, following its loss in that and several other cases, the Treasury Department amended the regulations to state that services performed by full-time employees—defined as employees who normally work 40 hours or more per week—are not incident to education and therefore are not eligible for the student exception (Treas. Reg. § 31.3121(b)(10)-2). The amended regulations also include an example that specifically excludes medical residents from the exception (section 31.3121(b)(10)-2(e), Example 4). The Mayo Foundation in 2006 returned to the district court, which held that the amended regulations were invalid because they were “arbitrary, capricious and unreasonable” (503 F.Supp. 2d 1164).
Before the Supreme Court, the Mayo Foundation again argued that the amended regulation is invalid because the statute is unambiguous and the 40-hour test is an impermissible interpretation of it. The IRS took the position that the statute is ambiguous, raising the question of which prior Supreme Court case applies when determining whether a tax regulation should be upheld. The district court had held for the taxpayer based on the less deferential, tax-specific standard of National Muffler Dealers Assn. Inc. v. U.S., 440 U.S. 472 (1979). The Eighth Circuit overturned that decision based on the higher-deference standard of Chevron USA v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984), which applies to all administrative agencies. Although the Supreme Court acknowledged that it had not previously distinguished between National Muffler and Chevron, it held that, absent a justification to follow the less deferential standard of National Muffler, the proper approach is that in Chevron, which asks whether Congress has directly addressed the precise question at issue and, if not, whether the regulation is a permissible interpretation of the statute. Further, the court clarified that there is no special standard for analyzing tax regulations and that Chevron applies regardless of the type of authority granted from Congress to the Treasury Department—general or specific—under which the regulations being analyzed were issued.
As applied to whether medical residents are subject to FICA, the Supreme Court found that IRC § 3121(b)(10) is silent on the definition of “student” and ambiguous as to how it should be applied to working professionals. It then found that the 40-hour test was a reasonable interpretation of “student.” The court stated that “[r]egulation, like legislation, often requires drawing lines,” and that the Treasury Department’s focus on hours is a “perfectly sensible” way “to distinguish between workers who study and students who work.” The court further found that the Treasury’s interpretation will avoid “the wasteful litigation and continuing uncertainty that would inevitably accompany any purely case-by-case approach” (quoting U.S. v. Correll, 389 U.S. 299 (1967)) and furthers the purposes of Social Security, which is funded by FICA taxes.
Mayo Foundation v. U.S., docket no. 09-837 (U.S.S.C.) (1/11/2011)
By Laura Lee Mannino, CPA, LL.M., associate professor of accounting and taxation, St. John’s University, Jamaica, N.Y.
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