Summary of Federal Laws
Tax Issues Related to Employment
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The Social Security Act (The Federal Old Age and Survivors Insurance Trust Fund and Federal Disability and Insurance Trust Fund, and the Federal Insurance Contributions Act (FICA))
The Social Security Act sets forth the requirements for eligibility on benefits. FICA defines which employers and employee are subject to taxation and levies the tax. An employer must pay social security taxes on employees but an exemption exists for most students also working for the university, and for clergy whose services are performed in the exercise of their ministry. See I.R.C. § 3121. Note the exemption for students is based upon the taxpayer being primarily a student, and not an employee who is taking a class or two.
Note from Bertrand M. Harding, Jr. on NIH National Service Research Awards and FICA applicablity as seen by IRS, posted with permission on 6/17/11:
In 2009, the IRS issued a detailed legal memorandum (CCA 200944027), which can be found at http://www.irs.gov/pub/irs-wd/0944027.pdf) explaining why a university's NIH National Service Research Award (NRSA) grants are bona fide fellowships and therefore not subject to FICA tax and why the non-NRSA grants at issue in that case were compensatory and subject to FICA. The university protested this decision, and IRS Chief Counsel's office has issued another detailed memorandum explaining why it believes that its initial determination was correct. This new memorandum -- CCA 201117026 can be found at http://www.irs.gov/pub/irs-wd/1117026.pdf.
Mayo Foundation v. United States, Case No. 09-837, January 11, 2011, U.S. Supreme Court
FICA requires employers and employees to pay taxes on all wages employees receive. In a long standing battle between Mayo Clinic and the IRS, the Supreme Court held that doctors who serve as medical residents are properly viewed as employees, and do not meet the definition of *students* set forth in 26 USC 3121(b)(10)and Treasury Reg. 26 CFR 31.3121(b)(10)-2. While medical residents are obtaining an education, most put in 50-80 hours per week in patient care. The Court did not see why the IRS should not be granted the deference due to other agencies in promulgating the regulations. The Court's holding is as follows:
We do not doubt that Mayo’s residents are engaged in avaluable educational pursuit or that they are students of their craft. The question whether they are “students” forpurposes of §3121, however, is a different matter. Because it is one to which Congress has not directly spoken, and because the Treasury Department’s rule is a reasonable construction of what Congress has said, the judgment ofthe Court of Appeals must be affirmed.
This decision will be effective retroactive to April 1, 2005 and wages paid from that date to medical residents will be subject to the FICA tax.
Sean Scally, University Counsel and Tax Attorney for Vanderbilt, provided the following write up of the Court's decision:
In what can be described as a grand slam home run decision for the IRS, the U.S. Supreme Court upheld the regulation establishing full-time employees (40-hours or more per week) of schools, colleges and universities as categorically ineligible for the FICA employment tax exemption. IRC 3121(b)(10). This 8-0 opinion (Justice Kagan did not participate) was challenged by Mayo Clinic/University of Minnesota in the context of medical residents; the effective date of the regulation is April 1, 2005, and for all subsequent periods.
The opinion, by Chief Justice Roberts, observes that Congress granted the Treasury Department/IRS the authority to adopt and administer interpretive regulations of a statute after the appropriate notice-and-comment procedure. After this effort, the IRS "reasonably concluded" that this bright-line "full-time employee rule" would "improve administrability" of the federal Tax Code and avoid wasteful litigation and continuing uncertainty which would occur if the "student" determination had to be done on a case-by-case basis.
IRS to Honor Medical Resident FICA Refunds
March 2, 2010 Press Release issued on IRS decision to accept the position that medical residents are excepted from FICA taxes based on the student exception for tax periods ending before April 1, 2005 when new IRS regulations went into effect.
Student FICA Guidelines
26 USC § 3121(b)(10) provides that service performed in the employ of a school, college or university by a student who is enrolled and regularly attending classes at such school, college, or university is exempt from the FICA tax. The regulation at 31.3121(b)(10)-2 (d) provides the following clarification on what qualifies as incident to and for the purposes of performing a course of study.
(3) Incident to and for the purpose of pursuing a course of study.
(i) General rule. An employee's services must be incident to and for the purpose of pursuing a course of study in order for the employee to have the status of a student. Whether an employee's services are incident to and for the purpose of pursuing a course of study shall be determined on the basis of the relationship of the employee with the organization for which such services are performed as an employee. The educational aspect of the relationship between the employer and the employee, as compared to the service aspect of the relationship, must be predominant in order for the employee's services to be incident to and for the purpose of pursuing a course of study. The educational aspect of the relationship is evaluated based on all the relevant facts and circumstances related to the educational aspect of the relationship. The service aspect of the relationship is evaluated based on all the relevant facts and circumstances related to the employee's employment. The evaluation of the service aspect of the relationship is not affected by the fact that the services performed by the employee may have an educational, instructional, or training aspect. Except as provided in paragraph (d)(3)(iii) of this section, whether the educational aspect or the service aspect of an employee's relationship with the employer is predominant is determined by considering all the relevant facts and circumstances. Relevant factors in evaluating the educational and service aspects of an employee's relationship with the employer are described in paragraphs (d)(3)(iv) and (v) of this section respectively. There may be facts and circumstances that are relevant in evaluating the educational and service aspects of the relationship in addition to those described in paragraphs (d)(3)(iv) and (v) of this section.
Student FICA Exception Final Rules, 69 Fed. Reg. 76404, Dec. 21, 2004
In addition to the final regulations, the IRS issued a revenue procedure providing a safe harbor for the student FICA exception. This Revenue Procedure 2005-11 replaces Rev. Prov. 98-16. The Revenue Procedure modifies the IRS prior guidance (Rev. Proc. 98-16, 1998-1 CB 403) to change the safe harbor standards formerly applicable to student employees deemed exempt from employment taxes. First, it makes clear that the final regs may make the FICA exemption unavailable to some organizations, such as teaching hospitals, if the entity's primary function is not conducting educational activities. Then it expressly eliminates some categories of employees from "safe harbor" treatment: (1) full-time employees, (2) professional employees, (3) career employees, and (4) employees "who are postdoctoral students, postdoctoral fellows, medical residents, or medical interns because the services performed by these employees cannot be assumed to be incident to and for the purpose of pursuing a course of study." The Procedure guidance states: "The employment activities of these individuals overlap with the activities arguably comprising a course of study, and thus is not appropriate to apply the standards of this revenue procedure to these individuals." Rev. Proc. 2005-11, Sec. 3.02. Yet, the safe harbor remains applicable to students (undergrad, grad or professional) enrolled at least half-time at a qualified SCU, and is not otherwise excluded elsewhere in the Procedure or by the final regs. Rev. Proc. 2005-11, Sec. 7. For an excellent overview of the social security tax exemption for students see Bert Harding's The Tax Law of Colleges and Universities, 2nd Ed. at pages 125-134.
International Student and Scholar FICA Exemption Rules:
University of Minnesota summary of the exemptions from FICA (5 years for F-1 and J-1 students, 2 years for J-1 Scholars) for those on different visas. Very helpful. No matter what part of the year the F-1 or J-1 visa holder originally entered the country, it is counted as a full calendar year when determining the exemption for FICA withholding.
Assignment of SSNs to Foreign Academic Students in F-1 Status, Final Rule; 69 Fed. Reg. 55065, Sept. 13, 2004. Effective Oct. 13, 2004.
The Social Security Administration is requiring additional evidence for F-1 students who are applying for SSNs. Like all other applicants, an F-1 student must provide SSA with evidence of age, identity, immigration status, and work authorization. In addition, unless the F-1 student has an employment authorization document (EAD) from DHS or is authorized by the F-1 student's school for curricular practical training (CPT), the F-1 student must provide evidence that he or she has been authorized by the school to work and has secured employment or a promise of employment before we will assign
an SSN. The student must submit their SEVIS Form I-20 and documentation from their designated school official (DSO) that includes a) the nature of the employment the student is or will be engaged in; and b) the identity of the employer for whom the student is or will be working. In addition, the student must provide a statement from their employer that verifying that the student is employed by or has secured employment with the employer.
Employer and Employee obligations with respect to procuring social security numbers
As codified in 26 CFR § 31.6011(b)-2
An employee who is in employment for wages which are subject to taxes under the Federal Insurance Contributions Act (FICA) or which are subject to the withholding of income tax from wages must apply for a social security number by filing Form SS-5. If the employee does not have a social security number at the time employment commences, the application shall be filed on or before the seventh day after the first day of employment. An account number will be assigned to the employee by the Social Security Administration in due course. (Language from the regulation)
If the employee already has the card, he/she shall show it to the employer upon commencement of hire. If the employee has a number, but cannot locate the card, the employee shall advise the employer of the number of the card, and how the name is shown on the card. If the employee has applied for a card and has the receipt for application of the card, the receipt shall be shown to the employer. If an employee does not yet have a social security card, and has not yet applied for one, the employee shall furnish to the employer a statement in writing, signed by the employee, setting forth the following on Form SS-5:
- date of the statement
- the employee's full name
- present address
- date and place of birth
- father's full name
- mother's full name before marriage
- employee's sex
- a statement as to whether the employee has previously filed an application on Form SS-5 and, if so, the date and place of such filing.
Giving this information to the employer does not relieve the employee of the obligation to make an application for a social security number. The employer can facilitate this process by supplying the necessary forms.
The institution has certain obligations as well. Once the employee gives the account number to the employer, the employer must enter the account number and name, exactly as shown on the card, in the employer's records, returns, statements for employees, and claims to the extent required by the applicable forms, regulations and instructions. If the employee does not show the employer the card, the employer should request the employee to do so. If the employee has not yet applied for an account number, the employer has an obligation to let the employee know of the requirement to do so. If the employee gives the employer the account number, or a receipt for application, this information shall be entered into the records. In the latter instance, the employer records the name and address of the employee as shown on the receipt, the expiration date of the receipt, and the issuing office's address.
If the account number is unknown when the return is filed as required for any period in connection with reporting of wages, the above collected information (contained on the application for a card) shall be entered upon the return. If the information was given to the employer on Form SS-5 or in a statement, a copy of this Form or statement shall be attached to the return. If the employee did not provide any of the above, the employer shall obtain and provide as much of the information referenced above as can be obtained, with an explanation of why it was not secured from the employee.
The regulations also suggest (this is not mandatory) that employers inform prospective employees of the requirement to apply for a social security card.
Selected Case Law and Other Resources
Cert granted by the US Supreme Court in Mayo Foundation, et. al v. United States on June 1, 2010, Case No. 09-837, See the Association of American Medical Colleges, ACE, AAU, and Association of Land Grant Universities Amicus Brief in Support of Petitioners seeking a Writ of Certiorari
15 page decision filed June 12, 2009 by 8th Circuit Court of Appeals holding that payments to medical residents do not quallify for the student FICA exemption, as medical residents are full time employees, and the exception is limited to students who are not full time employees.
The issue in this case is whether early retirement payments made by the University of Pittsburgh (the University) to its tenured faculty are taxable as "wages" under the Federal Insurance Contribution Act (FICA), 26 U.S.C. § 3121-28. The Court of Appeals agreed with the government that the retirement payments are wages, and vacated the District Court's holding in favor of the University.
Bert Harding memo titled New Developments in the Tax Treatment of Early Retirement Payments to Tenured Faculty (Feb. 2007) Reprinted with permission of Bert Harding. Tax Attorney Harding discusses conflicting case law and a recent IRS Action on Decision on the issue of whether early retirement payments made to tenured faculty are subject to FICA.
Appoloni v. U.S., 94 AFTR 2d 2004-5356 (July 21, 2004) (U.S. Dist. Ct. W. D. Mich.)
In this case the judge came to the opposite conclusion from the judge in the Klender case below, and held that retired public school teachers who received buy outs of their tenure rights must have the income treated as wages. Conceding that the Supreme Court has stated that while all wages under FICA are income, but not all income constitutes wages, the Court found the income in this instance to be wages subject to FICA as 1) the plaintiffs received the payments because of their employment relationship with the District, and 2) the Plaintiff's tenure rights were a benefit earned through prior service with the District.
Student Exception to FICA tax (IRS info page)
updated to clarify student status mlo 1-9-15
CCR updated CFR links 6/15/15