Court says medical residents’ stipends may escape income and FICA taxes

August 10, 2006

A district court has held that there is no “per se” statutory rule that as a matter of law automatically prevents stipends paid by a hospital to medical residents from qualifying for the scholarship exclusion from income or the FICA student exclusion. However, the court also went on to say that whether these exclusions applies depends on the particular facts and circumstances in each individual case.

Gross income does not include amounts received under a “qualified scholarship” by a degree candidate at a tax-exempt educational institution. However, any amount that represents payment for teaching, research or other services by the student which are required as a condition for receiving the scholarship is includable in income. Services performed in the employ of a school, college, or university, whether or not the organization is exempt from tax, or a affiliated organization, are not subject to the FICA tax if performed by a student who is enrolled and regularly attending classes at the institution. The IRS has concluded that medical residents and interns aren’t students for purposes of the FICA exception.

In the past, one district court has held that residents in graduate-level medical programs were entitled to the FICA student exception, finding that the services performed by the residents in connection with their clinical work had to be viewed as incident to and for the purpose of their medical education. U.S. v. Mayo Foundation for Medical Education & Research, (2003, DC MN). But another district court declined to follow the holding in Mayo Foundation, and instead held that a teaching hospital received an erroneous refund for FICA taxes paid and withheld on wages for medical residents. It concluded that the wages didn’t qualify for the student exception for FICA. The court noted that, according to the legislative intent of the Social Security Act, the FICA tax was intended to be imposed on all medical doctors, including those in training. (U.S. v. Mount Sinai Medical Center of FL, Inc. (DC Fl 1/19/2005).

In the current case, University Hospital, Inc. (University Hospital), a “teaching hospital,” sponsors many medical residency programs for medical school graduates, offering both medical specialties and sub-specialities. The residency programs include dentistry, dermatology, emergency medicine, neurology and internal medicine. They normally last at least three years, but could last for up to seven years. Under the contract a resident or intern signs, the hospital agrees to pay compensation, called a “stipend,” and provide a number of employee benefits: free medical malpractice insurance, pre-tax medical and dependent care spending accounts, long-term disability insurance, vacation and sick leave, health and dental insurance, life insurance, free parking, and a 401k retirement plan.

University Hospital initially paid FICA taxes on its medical residents’ stipends for ’99 and 2000. It then sought and received refunds of these amounts on the grounds that the stipends were not includable in gross income as scholarships and, alternatively, were excludable from FICA wages. The IRS attempted to recover what it claimed were erroneously refunded FICA tax payments. In return, University Hospital counter sued for refund of FICA taxes on residents’ wages paid for ’97, ’99, 2001, 2002, 2003, and part of 2004.

The district court, agreeing with University Hospital, held that whether the stipends are scholarships or eligible for the FICA student exception depends on the facts and circumstances of each case. First, the court rejected the IRS’s argument that legislative history indicated that Congress intended that medical residents are covered by FICA and that such stipends can never be considered scholarships or eligible for the student exception. It also rejected that IRS stance that medical residents’ stipends are not scholarships because a hospital extracts a quid pro quo from them.

A “qualified scholarship means any amount received by an individual as a scholarship…to the extent that the individual establishes that…such amount was used for qualified tuition and related expenses.” Thus, the court reasoned, the provision gives an individual an opportunity to prove that the amount received qualifies as a scholarship, rather than setting out a per se rule. The court stated that nothing in legislative history either stated or showed that Congress intended to make the stipends ineligible per se.

Finally, the district court also found the Internal Revenue Code (IRC Sec. 2121 (b)(10) unambiguous in that it didn’t categorically make stipends paid to medical residents ineligible for the exception. For the FICA exception to apply the court ruled, the taxpayer or employer must only establish: (1) the service was performed in the employ of a school, college, or university; and (2) the service was performed by a student who is enrolled and regularly attending classes at such school, college or university.

Previous post:

Next post: