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FICA Refunds for Housestaff

Background

The Federal Insurance Contributions Act (FICA) created Social Security, a contribution-based social insurance for the elderly, survivors and the disabled. This insurance system is funded through obligatory payroll deductions ("FICA contributions or taxes"). The FICA payroll tax is currently set at a rate of 7.65% of the employee's gross pay. A matching amount is paid by the employer.

Housestaff have historically participated in this employee-employer insurance system through their FICA contributions. However, the tax code exempts several groups such as students from the FICA tax. Services performed in the employ of a school, college, or university are exempt if the service is performed by a student who is enrolled and regularly attending classes at the school, college or university.

Recent Developments

On 21 July 2000, the IRS issued a chief counsel advice memorandum on the issue of Federal Insurance Contributions Act (FICA) refund claims with respect to medical residents. The memo guided IRS agents that the student FICA exemption could be met by residents if (1) the resident's common law employer is a school, college or university and (2) a resident has the status of student with the common law employer.

The advice memorandum was a response to an action in the 8th Circuit Court of Appeals on the matter of State of Minnesota vs. Apfel (1998). The State of Minnesota had petitioned the court for a FICA refund on the behalf of residents enrolled in the graduate medical education program at the University of Minnesota. The court concluded that the residents participated in the University of Minnesota's graduate medical education program for the primary purpose of education rather than for earning a livelihood.

The memo explains that a resident's common law employer is one which "directs and controls" a resident. The common law employer is not necessarily the entity that writes the resident's check as the Social Security Administration had argued.

The possibility now exists for residents who train in a school, college or university-based program to have their residency salary exempted from future payment of FICA taxes and have past FICA payments refunded. The significance of a FICA refund is apparent. For a hypothetical internal medicine resident earning $30,000 a year, the refund can amount to almost $2,300 per year.

Response

Unfortunately, the chief counsel advice memorandum does not have the weight of law. It only serves as a recommended framework for IRS agents to assess these refund claims, and the issue is currently being pursued through the federal court system.

There are two approaches for filing and receiving a FICA refund claim. The first is to file a personal refund claim. The second is for the training institution to work collaboratively with its residents to pursue a FICA refund claim.

Residents are strongly advised NOT to pursue the claim individually. According to Jeremy M. Watkins of Arthur Anderson LLP, which is representing a large southern university on this matter,

"Many of you have contemplated personally filing for refunds using IRS Form 1040X. The IRS has specifically noted that this is an invalid procedure and has denied such claims. Certainly some individuals have received refund checks for such filings, but they stand in jeopardy under further IRS scrutiny."

Several websites appear to be encouraging residents to seek refunds using Form 1040X. While some residents have filed and received a refund, if the courts ultimately provide an unfavorable ruling on the issue, residents who have received a refund could be subject to repaying the refund to the IRS with interest and possibly penalties.

The recommended approach is for residents to work with their training institutions to pursue the refund. The first step is for the institution to file a "protective refund claim". This legal filing essentially places a hold on past FICA payments. Without this filing, the statute of limitations for seeking a FICA refund expires after three years. So, 16 April 2001 was the last day to file a protective refund claim for FICA payments made during the 1997 calendar year. Similarly, a protective refund claim for 1998 FICA payments must be filed by 15 April 2002. According to the November 2000 issue of the ACP Observer, more than 200 hospitals and training programs have filed protective refund claims.

The second step involves a process called "perfecting" the claim. The tax director of a major midwestern university program, who is helping the university pursue its FICA refund claim, comments,

"The next step in this process, which is far more complex and time consuming step than filing the protective refund claim noted above, is the process that is being referred to in the industry as "perfecting" the claim. Based on a letter ruling issued by the IRS last year on this topic, universities must provide the IRS with a great deal of detailed payroll and residency program information which will serve as the supporting documentation and legal basis for the refund claims."

Only a handful of training institutions from the Midwest and South appear to have pursued this secondary process.

All of the "big 5" accounting firms have reportedly engaged the IRS in discussing resident FICA refund claims on behalf of their client training institutions. Mr. Watkins noted,

"(T)he IRS has placed this issue as a priority for resolution. Several large institutions around the country have been selected as the test-cases by which the IRS should issue rulings as to which institutions could potentially receive refunds. The IRS hopes to make this determination by the end of 2001."

Associate Action

For a resident, a refund of a couple thousand dollars per year of housestaff training represents a significant financial opportunity to pay down student loans and/or pursue other financial goals.

The first step a resident should undertake is to learn what position and actions the training institutions has taken with regards to the issue of resident FICA refunds. As mentioned above, more than 200 programs and hospitals have filed protective refund claims while the issue wends it way through the federal court system. For programs that have not filed a protective refund claim, the next major deadline (unless the IRS resolves the situation in the interim) is15 April 2002, which is when protective refund claims for the 1998 calendar year are due.

To convince a program to act, residents should keep in mind that training programs and hospitals have matched residents' FICA contributions. Depending on the number of housestaff at a program and whether the institution has filed protective refund claims, an institution stands to potentially benefit from a refund of its matching FICA payments of a million dollars or more. It may also be necessary to demonstrate to an institution's administration that there is resident consensus for pursuing a FICA refund. Program directors, local housestaff organizations, chief residents, and petitions may be helpful in convincing an administration of the wide support for pursuing a FICA refund.

Caveat emptor

Residents need to keep in mind the negative consequences of receiving a FICA refund. First, Social Security payments after retirement are based on an employee's total contribution and the number of years during which the taxes were paid. So, a refund will impact on a resident's Social Security retirement benefits. Second, Social Security disability benefits are also dependent on an individual's history of FICA payments. Since residency represents the first major source of income for many residents, a resident, who has not paid FICA taxes, could find himself or herself permanently disabled and with no or minimal disability benefits. Residents should consider the advantages and disadvantages of the issue before pursuing a FICA refund claim individually or allowing their training institution to pursue a FICA refund claim on their behalf.

Frequently Asked Questions (FAQ)

1. Why does the IRS consider residents as students when the National Labor Relations Board (NLRB) ruled that residents are employees?

The NLRB ruled in November 1999 that residents in private residency training programs had the right to form collective bargaining units. (Residents training in public institutions are governed by state labor laws.) The wording of the NLRB ruling makes it clear that "…while they [i.e. residents] may be students learning their chosen medical craft, [they] are also 'employees' within the meaning of Section 2(3) of the Act."

2. My university is pursuing a FICA refund claim, but why do they want me to give the institution permission to receive my refund and give up my right(s) to pursue the FICA refund individually?

There are two parts to the FICA tax - the tax paid by the employee and a matching payment made by the employer. For the institution to pursue a refund, it needs to ensure that there are no "competing claims". There would certainly be confusion if the employee/resident filed a refund claim and the institution filed a refund claim for the same tax money. If the institution's refund claim is successful, the midwestern university's tax director states, "[T]he entire refund claim would be paid to the university, as employer/withholding agent. Then the university would be obligated to return the employee's portion of that refund to them, after receiving the refund from the IRS."

Institutions are better equipped in terms of legal resources and financial wherewithal to participate in the current litigation in the federal courts. Furthermore, in this situation, the financial interests of the institution and most residents coincide. Residents are encouraged to actively monitor the institution's efforts and progress on this issue.

3. When can I receive my refund check?

There are substantial doubts that the IRS will decide to apply the student FICA exemption to residents. Remember there is the ongoing concern that the Social Security Trust Fund will be inadequate to fund current benefit levels when all of the baby boomers retire. Furthermore, there are several factual details that make the University of Minnesota's case unique. The primary fact is that residents at the University of Minnesota actually pay tuition as part of their residency training program. While there is some anticipation that the issue will be resolved by the IRS prior to the end of the 2001 calendar year, this is by no means certain.

Disclaimer

The Council of Associates seeks to represent and advocate on behalf of the Associate members of the American College of Physicians (ACP). This report presents information and recommendations gathered from reliable sources. However, individuals should consult with appropriate professionals before undertaking any financial decisions based on the information contained in this report.

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