IRS Faceoff With Medical Residents Set for High Court

(June 1) -- The Supreme Court announced today that it will diagnose a medical mystery: whether medical residents are students who don't have to pay Social Security taxes, or regular working stiffs like the rest of us.

About $700 million a year in Social Security and Medicare taxes -- not to mention the bottom lines of some 100,000 medical residents and the institutions they work for -- rides on the outcome.

Congress decided in 1939 that students should be exempt from Social Security taxes. But the IRS has argued in court for years that medical residents who work 40 hours or more (as nearly all do) aren't "students."

In 2005, after losing its case in several of the nation's judicial circuits, the IRS passed a regulation disqualifying medical residents from the tax break. Now, by announcing it will hear the case Mayo Foundation for Medical Education and Research v. United States in its next term, the high court will decide if the IRS had the right to do that.

"These are students receiving a stipend between $40,000 and $60,000 a year and working 80 hours a week in a hospital setting, in addition to attending classes, writing research papers and doing outside research," said Amir Tayrani of Gibson, Dunn & Crutcher, and an attorney for the Mayo Foundation and the University of Minnesota, who have residency programs and are fighting the tax.

Ivy Baer, regulatory counsel for the Association of American Medical Colleges, agreed that medical residents should be treated as students. "It takes a lot of hours to get someone from [being] a graduate of a medical school to being able to practice independently," she said. "They are still being trained."

After graduating from medical school, most would-be doctors spend three to five years in residency and fellowship programs. Baer said they cannot even get a medical license without a residency.

But a brief filed on behalf of the government by Solicitor General Elena Kagan (now a Supreme Court nominee) argues that residents working full time are not students. Because the law giving students a tax break was ambiguous in defining "student," the IRS has the right to do so, she argued.

Kagan also argued that the point of the Social Security and Medicare tax (called FICA) is to collect "contributions during an employee's entire working career in order to fund benefits in retirement."

When Congress exempted students, it intended only to do so for "employment that generates nominal wages and exemption of which will not result in significant loss of Social Security and Medicare benefits," according to the brief. (The IRS referred questions on the case to the Justice Department, which refused to comment.)

The FICA tax is paid by both employer and employee. Lawrence Hughes, assistant general counsel for the American Hospital Association, said if medical institutions don't owe the tax, they could spend the money on residency training and community programs.

The brief filed by the Mayo and Minnesota programs said all the residents' work is designed to be educational. Hospitals, in fact, could save money by not having residents "because of the time and effort required to supervise and teach them."

The two sides disagreed over whether the Supreme Court needed to hear the case. The government, which won the case at the appeals level, said the 2005 IRS regulation had cleared up the disagreements over the issue and now all full-time residents are subject to the tax. But Tayrani said the Supreme Court needs to settle the issue. Residency programs have won in four other appeals courts and students in some regions could be exempt from the tax while others pay it, creating unfairness, he said.

The ruling would affect about 8,000 residency programs, along with the medical residents. And $2.1 billion is pending in refund claims from residents and their employers.