FICA Medical Resident Update and April 15th Filing Deadline
April 3, 2003
February 28, 2003, was the date that many tax advisors to the health care industry had circled on their calendars as the date that clarity and some degree of closure would finally be brought to the Federal Insurance Contributions Act (FICA) medical resident issue—one of the most vexing tax issues facing hospitals today. Neither occurred. Instead, the issue will likely continue to plague the industry and its advisors for quite some time. This is because the parties to United States v. Mayo Foundation for Medical Education, have been unable to settle their case, and the IRS has failed to issue any settlement guidelines.
The federal judge presiding over the Mayo Foundation case had established February 28, 2003, as the final settlement date before the case would be rescheduled for trial. Due to the court filings and intervening Internal Revenue Service (IRS) informal guidance, as well as various rumors that have circulated within the health care industry, some advisors widely anticipated that the disposition of Mayo Foundation would lead to the establishment of settlement guidelines applicable to the many other hospitals that had filed FICA tax refunds or claimed FICA tax adjustments. Instead of much needed clarification, the confusion is likely to increase as those hospitals affected by this issue are left to guess at the decision of this court and the other authorities that are trying to analyze the FICA medical resident issue. In the intervening period, hospitals should continue to file protective refund claims no later than April 15 to protect their refund rights.
Minnesota v. Apfel
In 1998, the U.S. Court of Appeals for the Eighth Circuit determined that the state of Minnesota was not liable for FICA taxes on amounts paid to medical residents in the University of Minnesota’s graduate medical program. That case, Minnesota v. Apfel, involved an assessment by the Social Security Administration (SSA) against the state for FICA taxes allegedly owed on payments to the medical residents. The district court had previously held in favor of the state of Minnesota on the alternative grounds that the medical residents were not “employees” within the intended meaning of the state’s Section 218 agreement. Even if they were employees under the Section 218 agreement, they were excluded from coverage under the agreement’s “student exclusion.” The appellate court affirmed both alternative grounds.
The SSA acquiesced in the Minnesota v. Apfel case, agreeing to apply case-by-case examinations of the relationship between medical residents and the hospital, but the acquiescence only applies to hospitals located in the Eighth Circuit and those covered by a Section 218 agreement. In contrast to the SSA, the IRS has not acquiesced to the decision for those hospitals that pay FICA taxes pursuant to the code’s statutory provisions as contrasted to a Section 218 agreement’s contractual provisions.
The Minnesota v. Apfel case generated significant interest, resulting in hundreds of hospitals filing claims for refunds or adjustments of FICA taxes deposited in connection with stipends paid to their medical residents. Most of the hospitals that filed the claims for refunds are not university hospitals and do not have Section 218 agreements.
The IRS and SSA have generally responded negatively to the claims for refunds that have been filed based on the Minnesota v. Apfel decision. More specifically, the IRS has attempted to deny or suspend all refund claims and has initiated litigation on the issue of whether the FICA tax exclusion for students in Section 3121(b)(10) applies to medical residents in teaching hospitals. Not surprisingly, the IRS has currently adopted a narrow interpretation of Section 3121(b)(10) as it applies to such cases.
Notwithstanding the IRS’ general position, a significant number of refund claims were previously granted and even more FICA adjustments were successfully claimed. After in-depth analysis by the IRS National Office and the publication of several legal memoranda, the IRS has now indicated that it will seek return of the refunds it deems to have been erroneously made. In fact, it is still attempting to determine which hospitals received these “erroneous” refunds.
Mayo Foundation
As indicated above, many advisors believed that the litigation involving the Mayo Foundation and the other related defendants in that case would significantly clarify the issue either through a judicial resolution (especially since the case would be appealable to the Eighth Circuit where the Minnesota v. Apfel decision was issued) or through the wide dissemination of settlement guidelines or procedures issued by the IRS in response to the case. Consequently, it is important to gain a better understanding of this litigation.
On April 15, 1999, Mayo filed four claims for refund (one for each quarter in 1995) for the FICA taxes paid and withheld on amounts paid to medical residents and fellows. Unlike the Minnesota v. Apfel decision that involved a Section 218 agreement, the refunds were filed on the sole ground that the amounts paid to the medical residents should have been excluded from “employment” pursuant to the student FICA exception under Code Section 3121(b)(10). Significantly, Mayo did not assert as grounds for its refund claim that the amounts should also have been excluded under the alternative argument that the amounts were excludable from “wages” as a fellowship stipend under Code Section 3121(a)(20).
In July 1999, the IRS refunded the 1995 FICA taxes claimed, plus interest, in the total amounts of $4,131,372.87. On June 22, 2001, and just prior to the expiration of the two-year statute of limitations for erroneous refunds, the U.S. Department of Justice filed a Complaint for Recovery of Erroneous Refund. During the ensuing months, the parties engaged in a series of motions, discovery efforts and settlement conferences. Due to ongoing settlement negotiations, the court issued an order on September 3, 2002, staying the proceedings and delaying the trial.
District Court Judge Richard Kyle issued an order on January 9, 2003, that required the litigation to be settled on or before February 28, 2003. If the parties failed to reach a settlement, the court would enter an order on March 3, 2003, vacating the order dated September 3, 2002, staying the proceedings. This placed the case on the court’s trial calendar for May 1, 2003, and the court directed the parties to exchange and submit all trial materials no later that April 1, 2003. Subsequent settlement negotiations between the parties apparently broke down not because of the IRS’ unwillingness to accept Mayo’s settlement offer (the settlement offer was apparently approved by the IRS, the trial attorney and the trial attorney’s section chief), but apparently because the assistant attorney general for the Tax Division either refused to approve or disagreed with the settlement offer. Whatever the reason, the court by order dated March 11, 2003, set a “Final Settlement Conference” for April 8, 2003, requiring all parties to attend with full settlement authority. The court issued a separate scheduling order setting the matter as “ready for trial” as of May 1, 2003, consistent with its earlier orders.
Due to the secretive nature of the Mayo settlement negotiations and the IRS’ failure to issue broader settlement guidelines, the industry must now turn to other means for clarity and closure of this issue. Since the legislative solution discussed by many now appears to be dead, the likely avenues for resolution remain administrative guidance and/or litigation. From our years of involvement with the issue and our many years at the IRS National Office in the division handling this issue and our knowledge of those addressing the issues, we believe that an administrative solution is possible, but not necessarily probable due to the fact sensitive nature of many of these cases. In addition, the prospects for a broader industry settlement were likely set back with the retirement of a key IRS official who was closely involved with this issue.
The accounting firms that filed the bulk of FICA refunds and adjustments have begun to look at the other cases that will either replace or supplement the Mayo Foundation case as the vehicle to resolve this issue. The next most prominent case that has already become the focus of the accounting firms and others involved with this issue is United States v. Mount Sinai Medical Center of Florida. Unlike the Mayo Foundation litigation, the Mount Sinai litigation will have broader impact since it is not limited to the Section 3121(b)(10) issue. Alternative legal grounds were raised in the underlying refund claim and in the answer to the government’s complaint that also assert an exclusion from FICA taxes based on the Section 3121(a)(20) wage exception.
Even though several years have passed since those first FICA refund claims were filed, questions remain regarding the status of the refund claims. It was anticipated that the federal district court in the Mayo Foundation litigation would answer many of these questions. Notwithstanding the questions that still remain, three points seem relatively clear from the developments since those first refund claims were filed: the IRS is challenging the refund claims after initially allowing many of them; considerable legal arguments support the refund claims such that hospitals must continue to preserve their legal rights and those of the affected medical residents; and the most definitive and final resolution of this issue will now be through litigation in the courts.
The April 15th Filing Deadline—What to Do Now
No matter how hospitals approach the broader legal issue, all hospitals should, at a minimum, file protective refund claims no later than April 15, 2003, to preserve their refund rights, as well as those of their medical residents. On April 16, 2003 the statute of limitations expires for any FICA tax refunds for the 1999 calendar year if a protective refund claim has not been filed. In sharp contrast to a traditional refund claim, a protective refund claim is a simple and inexpensive method to preserve all rights while the issue continues to be litigated. A protective refund claim specifically recognizes that the law may not be settled on a particular issue, and yet, an organization may be facing an expiring statute of limitations beyond which any refund would be time barred. In these circumstances, an organization may file a protective refund claim with the IRS to prevent the statute of limitations from barring the claim. In essence, a protective refund claim allows a taxpayer the luxury of preserving a claim potentially worth millions of dollars while expending very minimal administrative and monetary resources. Due to its protective nature and streamlined process, a protective refund claim should be easy to file by the hospital itself or with minimal assistance or advice from outside tax advisors. However, the failure to file on or before April 15, 2003, will permanently foreclose the ability to seek any overpaid FICA taxes associated with the pending medical resident FICA tax issues for 1999.
