Summary of Federal Laws

 

Tax

 

Tax Issues Related to Employment                                    

Compliance Partners

Director of Payroll

 

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))

 

I.R.C. § 3101 et seq., and 42 U.S.C. § 401 et seq.; 20 C.F.R. § 404.1028(c), 26 CFR § 31.6011(b)-2, 26 C.F.R. § 31.6302.1 et seq.

 

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 and also 1984 EO CPE Text.

 

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.

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

 

Mayo Clinic v. US; Regents of University of Minnesota V. US of America

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.

 

 

University of Pittsburgh v. U.S. ( C.A. 3, Nov. 2, 2007)

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.

 

Klender v. U.S., Case No. 02-10082-BC, (U.S. Dist. Ct. E.D. Michigan)(Aug. 2, 2004)

This case presents the issue of whether buy out payments made to public school teachers to induce them to relinquish their tenure rights and retire early constitute wages from which deductions must be made under FICA. The court found that the payments made for the sale of these rights do not constitute remuneration for employment. In reaching this conclusion, this decision, which hails from within the 6th Circuit, is in accord with the 8th Circuit 2001 decision in North Dakota State University v. U.S.; 255 F. 3d. 599 (8th Cir. 2001). The government had tried to distinguish the North Dakota case from this case, and was not successful. In a key paragraph, the judge in Klender noted the following:

 

The Court believes that the principled method of distinguishing "wages" from other employer payments articulated by the Treasury Department in its revenue rulings, fully discussed by the North Dakota court, is to focus on the purpose of the payments. Payments for past or future service, or in recognition of past performance, are wages subject to the tax. Payments for other purposes are not. Or in the words of the Gerbec court, payments "attributable to wages [workers] would have received had they not been wrongly terminated should also be subject to the FICA taxes" irrespective of whether the worker was still employed at the time the payment was made. Gerbec, 164 F.3d at 1027. Compensation for the deprivation of other rights are not subject to taxation. Id. at 1025.

 

Resources

 

Vanderbilt summary of student FICA exemption for students in F and J visa categories
********

 

links updated 3/12/09 rab

compliance partner added 3/14/09 mlo
compliance box links updated 6/2/09 rab

updated by mlo 6/16/09 to add Mayo Clinic case

updated 8-25-09 to add student and scholar FICA exemption rules mlo