Medical Schools Must Pay Social Security Taxes for Residents, Supreme Court Rules

January 11, 2011

In a decision that will cost medical schools and teaching hospitals an estimated $700-million annually, the U.S. Supreme Court ruled unanimously on Tuesday that full-time medical residents in training are employees, not students, and are subject to Social Security and Medicare taxes.

The ruling, which representatives of medical colleges were quick to criticize, ends a longstanding dispute over whether medical colleges must pay the employer's portion of the taxes for their medical residents.

Before 2005, medical colleges did not have to pay the taxes, called FICA, for residents, even though they often work well beyond 40 hours a week--the medical colleges argued that the work was related more to their educational experience. In 2005, however, the IRS issued new rules that erased the exception for students who are essentially full-time employees, such as medical residents.

The case, Mayo Foundation v. United States (No. 09-837), involved the Mayo Clinic, in Rochester, Minn., and the University of Minnesota, which won a federal district-court ruling in 2008. In that opinion, the judge found that rules issued by the U.S. Treasury Department in 2005, excluding full-time medical residents from the student exception, were invalid because they were contrary to the law that created the Social Security system.

A three-judge panel of the U.S. Court of Appeals for the Eighth Circuit overturned that decision in 2009, saying the exception for students was meant only for those who worked part time while attending classes, but not medical residents, who are basically full-time employees of the teaching hospitals.

Four other federal appeals courts, in the Second, Sixth, Seventh and 11th Circuits, had ruled to the contrary, saying that the Internal Revenue Service must consider the situation at each institution rather than automatically applying the rule to exclude all medical residents from the student exception.

But on Tuesday, the Supreme Court said quite simply that the Treasury Department's rules about student employees are a valid interpretation of the federal tax laws and deserve legal deference.

"The [Treasury] Department reasonably sought to distinguish between workers who study and students who work," Chief Justice John G. Roberts Jr. wrote in the opinion. "Focusing on the hours spent working and those spent in studies is a sensible way to accomplish that goal. The Department thus has drawn a distinction between education and service, not between classroom instruction and hands-on training."

Sean P. Scally, university counsel and tax attorney for Vanderbilt University and Medical Center, said the court's reasoning was "remarkably thin" and seemed to find an administrative solution in order to make it easier for the IRS to collect taxes rather than a legal remedy that deals with the statutory issues. Instead of considering the facts and circumstances at every medical college, he said, the court has established a bright line that says any resident working more than 40 hours a week is required to pay the FICA taxes.

And because the decision will apply to all students who work more than 40 hours, Mr. Scally said, colleges will have to track the weekly earnings of student workers much more closely.

One positive result of the Supreme Court's decision, Mr. Scally said, is that medical colleges are still eligible for a refund of FICA taxes that they paid for residents before April 2005, when the IRS enacted the rule that students who were employed full-time were subject to those taxes.

Ivy Baer, a lawyer for the Association of American Medical Colleges, said she was disappointed by the ruling, but even a victory in the case would have had a limited impact, applying largely to teaching hospitals affiliated with universities.

Ms. Baer added that she doesn't think that the ruling will cause medical colleges to change requirements for residents to work extensive hours because those standards are usually set by accrediting agencies.

Theodore B. Olson, the former solicitor general who argued the case on behalf of the Mayo Clinic, issued a statement saying: "As the court itself acknowledged, medical residents are engaged in a formal and structured educational program that is an indispensable component of their medical training. The Treasury Department's regulation overlooks the important educational pursuits in which residents are engaged."