Full-Time Medical Residents Not Exempt From FICA

Several circuits have ruled on whether medical residents are eligible for the student exception to FICA (see “Tax Matters: FICA for Medical Residents Splits Circuits,” JofA, Jan. 08, page 73). Until recently, the issue had been whether a medical resident could be considered a “student” and a hospital could be considered a “school, college or university” as those terms are used in IRC § 3121(b)(10). However, in the latest twist, the Eighth Circuit was asked in Mayo Foundation v. United States to determine whether newly amended regulations under section 3121 restricting the exemption to student-employees who work less than 40 hours a week are valid. The court held they are.

In 2003, a district court held in Mayo Foundation that a case-by-case examination was required to determine whether medical residents are eligible for the student exemption (Mayo I). The regulations in effect at that time stated that the phrase “school, college or university” should be taken in its generally accepted sense, and an employee of such school, college or university could be considered a student if the performance of services was incident to and for the purpose of pursuing a course of study. Finding the terms satisfied, the district court ruled in favor of the taxpayer in Mayo I. The government filed an appeal, which it later withdrew, and published a notice of proposed regulations to amend the regulations under section 3121(b)(10).

The amended regulations, which were finalized and became effective April 1, 2005, (Treas. Reg. § 31.3121(b)(10)-2) say that an organization cannot be a school, college or university unless its primary function is the presentation of formal instruction, and any employee working 40 hours or more per week is not eligible for the exemption because the services are not incident to education. As a result, medical residents who work 40 or more hours a week no longer qualify for the student exemption. Mayo Foundation returned to district court in 2005, claiming that the amended regulations were contrary to the plain meaning of the Code, and the district court agreed (Mayo II).

The Eighth Circuit, however, found the 40-hour limitation to be valid because it harmonizes with the plain language of the Code, which is silent or ambiguous on the issue of medical residents. The opinion cited several Supreme Court decisions that uphold regulations that interpret words in a manner different for tax purposes than the words’ generally accepted meanings in other contexts. Notably, the Eighth Circuit observed that the Supreme Court has continually held that an administrative agency such as the IRS is entitled to amend its regulations in response to adverse judicial decisions as long as the amended regulations are a reasonable interpretation of the statute. Finding the 40-hour limitation valid, the court did not address the validity of the “primary function” test.

By Laura Lee Mannino, CPA, LL.M., associate professor of accounting and taxation, St. John’s University, Jamaica, N.Y.