Medical Residents Held Subject to FICA

In the case of University of Texas System v. U.S., 759 F.3d 437, (2014) the U.S. Supreme Court on April 27, 2015 declined to review a decision of the U.S. Fifth Circuit Court of Appeals which, affirming the district court, held that medical residents working for the University of Texas System were subject to FICA tax because the agreement between the State of Texas and the Social Security Administration (SSA) did not exclude the residents from the Social Security system.

In accordance with 42 USC 418 (“Section 218” of the Social Security Act) a state may define, to a limited extent, those state employees who will participate in Social Security by agreement with the Commissioner of Social Security (the “Commissioner” and “SSA”).  Known as a (“418 or 218 Agreement”), the agreements are incorporated in the Internal Revenue Code (“IRC”) by excluding from FICA taxation “service performed in the employ of a State” unless that service is “included under an agreement entered into pursuant to §218 of the Social Security Act.” (IRC §3121(b)(7)(E))

Also, by way of such agreements, states may provide exclusions in their agreements to ensure that certain employees are not included through the §418 agreement. One of the exclusions that a state may include within its § 418 agreement is for “service performed by a student” (42 USC 418(c)(5)), which is defined as applying to service performed in the employ of a school, college, or university if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university. (42 USC 418(c)(5), 42 USC 410(a)(10))

In Mayo Foundation for Medical Education and Research v. U.S. 568 F.3d 675 (2009), aff’d, 562 U.S. 44 (2011) the Supreme Court, unanimously affirmed a decision by the U.S. Court of Appeals for the Eighth Circuit, which upheld the validity of Internal Service regulations that disqualified medical residents from the IRC FICA student exception because they were full-time employees.

The longstanding position of the Commissioner pursuant to a 1978 ruling was that resident physicians are not students.  However, in Minnesota v. Apfel, 151 F.3d 742 (1998) the U.S. Court of Appeals for the Eighth Circuit declined to defer to the SSA ruling and indicated that it would review the facts of each case in making a determination of student status.  The SSA, in response to that case, stated that it would apply Apfel‘s case-by-case approach in the Eighth Circuit.

The State of Texas entered into a §418 agreement many years ago. The agreement was modified to exclude students from coverage.  The University of Texas (the “University”) was withholding from medical residents and paying in for them FICA and it continued to do so after it modified its agreement with SSA.

Many years passed before the University sought FICA refunds regarding its medical residents.  It sued for a refund of FICA taxes paid for the medical residents on the ground that they were exempt under the student exclusion added to Texas’s §418 agreement. The district court ruled in favor of the government and the University appealed.

The Fifth Circuit determined that the relevant law was contract law.  As a matter of contract law, and relying on the Restatement (Second) of Contracts (the “Restatement”), the court opined that, at the time when the student exclusion was added to Texas’s §418 agreement, the SSA, prior to the modification by Texas of its §418 agreement:

  • Clearly disclosed its understanding that medical residents did not fall within the meaning of the term “student” as that term is used in the student exclusion that states could incorporate into their § 418 agreements;
  • Cited its longstanding position that resident physicians are not students;
  • Reaffirmed its position after Apfel that the services performed by medical residents do not qualify for the student exclusion; and
  • Made clear that it would employ the case-by-case approach used in Apfel only in the Eighth Circuit.

The failure of Texas to disclose to the SSA that it took a different view of the student exclusion than that of the SSA was fatal to its case.  Also, the past performance of Texas in handling FICA payments, even after the state modified its §418 agreement, indicated acceptance or acquiescence by Texas to the position of SSA.

Texas argued its agreement ought to be interpreted based on extrinsic evidence of whether a state made its position known to SSA, even if the state relied on long-standing federal regulations, as indicated by the Fifth Circuit and that the Fifth Circuit erred by drawing an adverse inference in interpreting the agreement through extrinsic evidence of the state’s election to pay FICA and failure to seek a timely refund.  The state also argued that the decision in Mayo, was inapposite, because it failed to discuss the state employee exemption and the optional exclusions under a §218 agreement.

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