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Please do not contact CAHC for personal tax information. Contact your personal tax advisor for further information.

NEW INFORMATION (June 18, 2013):

All fund have arrived and been disbursed as of today. The Consortium is required to file Form 1099-INT with the IRS and furnish a copy to you by January 31, 2014. In addition, the Consortium will file Form W-2c, Corrected Wage and Tax Statement, with the Social Security Administration (SSA), and furnish a copy to you for each tax year that you received a refund of FICA taxes. Form W-2c will show a reduction in your earnings for social security and Medicare purposes. This amount will be equal to all the wages you were paid for services performed as a resident/fellow for each year that you received a FICA refund.

Both Form 1099-INT and Form w-2c will be sent to you no later than January 31, 2014.



June 18, 2010 Vol. VIII Issue 24
Update On Next Steps For Teaching Hospitals To Recover FICA Tax Paid On Stipends Paid To Medical Residents
By Thomas D. Sykes, Greenberg Traurig, LLP*

Within a span of seven days, two noteworthy events occurred recently in the extended controversy over whether Federal Insurance Contributions Act (FICA) tax was and is properly due from teaching hospitals and their medical residents with respect to stipends paid to the residents. Discussion placing these events in context, and setting out some recommended next steps, is in order.

First, on May 25, 2010, the Internal Revenue Service (IRS) sent a CD to teaching hospitals with timely pending tax-refund claims that sets out detailed instructions on the procedures for obtaining the tax refunds due pursuant to its announcement of March 2, 2010 that it would no longer dispute that medical residents come within the Student Exception from FICA tax for taxable quarters before April 1, 2005.  (Stated simply, the Student Exception, found in 26 U.S.C. § 3121(b)(10), provides an exemption from FICA tax for services provided by a student employed by a school, college, or university.)

Second, and quite surprisingly, on June 1, 2010, the United States Supreme Court announced that it would review a decision made in 2009 by the U.S. Court of Appeals for the Eighth Circuit (in the Mayo Foundation/University of Minnesota case) that held valid a Treasury Regulation that precludes stipends paid to medical residents from qualifying for the Student Exception from tax for taxable quarters starting on and after April 1, 2005 (the 2005 Regulation).

These two recent events are of keen interest to teaching hospitals and medical residents because billions of dollars in tax refunds are at stake in connection with each of the two “buckets” of claims.  It is common for a teaching hospital to have many millions of dollars of employer-portion tax riding on the disposition of each of the two “buckets.”  And residents, in the aggregate, have a like amount of FICA tax at stake (because FICA tax consists of employer- and employee-portions of tax, in equal amounts).

The IRS’ Implementation of Its Announcement Allowing Administrative Refunds for Taxable Quarters Before April 1, 2005

On March 2, 2010, after court battles that had gone back and forth for more than a decade, the IRS threw in the towel, announcing that it would no longer dispute, for quarters before April 1, 2005, that teaching hospitals with timely refund claims on file qualify for tax refunds under the Student Exception from FICA.  Residents likewise qualify if they or their teaching hospitals have timely refund claims on file.

This announcement set the stage for the IRS administratively to refund billions of dollars to teaching hospitals and residents.  (April 1, 2005 was chosen as the cutoff because that is the effective date of a Treasury Regulation, discussed below, which purports to reverse the conclusion reached by the courts during the litigation.)  Many teaching hospitals will recover tens of millions of dollars under this announcement; a typical resident will recover between $9,000 and $12,000.  The announcement reflects one of the largest capitulations respecting a litigated issue in IRS history.

On May 25, 2010, the IRS implemented its historic announcement by sending teaching hospitals a CD setting out next steps for obtaining refunds for themselves and their residents.  These procedural materials instruct teaching hospitals to designate, by July 9, 2010, the professional representatives who will be handling their claims before the IRS.

Upon receiving that designation, the IRS will provide the representatives with a schedule (Form 8503E) on which the IRS lists the quarters before April 1, 2005 for which the teaching hospital, according to the IRS’ records, has a timely filed pending claim for refund.  The schedule will not include quarters for which a timely claim for refund was not made (according to IRS records). Under the non-waivable statutes governing tax refunds, a refund is permitted only in response to a timely refund claim.  Typically, a refund claim is timely if it was filed within three years of April 15 of the year following the year in which the FICA tax was paid.

Under the procedures set out in the CD, teaching hospitals are required to contact the residents who paid employer-portion tax for the quarters for which a refund is available; the teaching hospital is required to notify the residents that they have an opportunity to participate in the refund-recovery process.  Sample consent forms and cover letters are included in the IRS’ materials. Use of the samples provided is not mandatory, so customization with explanatory and risk-management features is permitted (and recommended by knowledgeable advisors).  The materials require that residents be given at least 45 days within which to respond with their consent or non-consent.  A resident’s non-consent or non-response has no effect upon the teaching hospital’s right to recover its employer-portion tax.

Amounts paid to residents for “non-resident services” will not qualify for the recovery.  For example, tax paid on a salary paid to an attending physician who, after completing a residency on June 30 became an attending on July 1, would not be refundable.

The spreadsheet stipulated by the CD seeks to have a teaching hospital set out quarterly amounts of stipends and related tax.  But many teaching hospitals will have difficulty compiling quarterly numbers, especially for years in the 1990s -- but little difficulty compiling annual numbers.  This raises a question about the extent to which the IRS will permit the use of annual numbers that are prorated by quarters (perhaps with some commonsense adjustments).

The spreadsheet requires a teaching hospital to set out the ACGME program number for each participating resident.  But programs that do not have ACGME approval nonetheless provide a basis for a refund to teaching hospitals and residents. Fellowships appear to provide a basis for a refund.  
The IRS requests, for each claim for refund, copies of documentary evidence substantiating that the refund claims were filed (i.e., mailed) in timely fashion.  Many teaching hospitals will be unable to locate that documentary evidence -- not much of a surprise given that pending claims sometimes go back as far as 1994.  The rigor with which the IRS will insist upon “perfect” documentary evidence is currently unclear.

In the event that the IRS is rigorous, disputes will ensue. These disputes will presumably be resolved by referring to abundant but often unharmonious case law under 26 U.S.C. § 7502 -- the statute setting out the timely-mailing-is-timely-filing rule -- addressing the quantum of evidence sufficient to prove timely mailing. Teaching hospitals would be given an opportunity to resolve the dispute with the IRS based upon the “hazards of litigation” standard, taking into account the case law.  If the dispute cannot be resolved, teaching hospitals would have access to the courts.

Teaching hospitals reportedly will have 120 days from the date of their receipt of the Form 8503E schedule within which to provide the requested materials.

After receiving the materials from the teaching hospitals, IRS will process the refunds based upon a full concession of the substantiated amounts. No differentiation in the refund will be made between teaching hospitals that are, or are not, part of a university. (The IRS lost cases involving stand-alone teaching hospitals.)  No reduction of the refund will be made for the Medicare Offset defense, which the Department of Justice has consistently pleaded in tax-refund suits. But if a teaching hospital is already in court on these years and decides to stay in court instead of dismissing its case and participating in the IRS’ administrative process, the Department of Justice appears to be willing to settle -- but only if the recovery is reduced by some percentage to account for the Medicare Offset defense. A settlement with DOJ in a case in which the Medicare Offset issue has been pleaded by DOJ would bind CMS.  By contrast, it is far from certain that IRS’ administrative refund process would bind CMS down the road.

Teaching hospitals will be responsible for preparing and distributing individual refund checks to residents who have opted in to the administrative refund process.

Interest computations, perhaps applying interest-netting rules, will have to be made.  It is unclear how long the entire refund process might take before the refund checks are actually available, so teaching hospitals should refrain from making any promises to residents on the point.  Teaching hospitals, however, will most likely be able to “book,” for financial purposes, the likely amount of the employer-portion refund long before the checks actually arrive.

Teaching hospitals that previously received “self-help” credits by way of a Form 941c will be permitted to keep the employer-portion of those credits.  Unresolved issues may exist with regard to undistributed employee-portion tax previously recovered by way of a self-help credit. Teaching hospitals seeking a refund under the administrative process are required to certify to the IRS that they did not previously receive “self-help” credits for that tax under a Form 941c.

At the end of the administrative refund process, teaching hospitals will be required to prepare and file Forms 1099 respecting the interest that is paid to the opt-in residents.  Teaching hospitals are also required to prepare and file Forms W2c showing the reduced amount of Social Security and Medicare wages for earnings-record and benefit purposes.

The IRS has staffed the refund project with personnel from the Odgen Service Center.  If a teaching hospital has questions about the refund process, a special phone number to the Ogden personnel is set out in the materials on the CD.

II. The Supreme Court’s Announcement That It Will Review the Validity of the 2005 Regulation Purporting Categorically to Disallow Refunds for Taxable Quarters after March 31, 2005

On June 1, 2010, the Supreme Court announced that it would review the validity of the 2005 Regulation.  The Court is obliged to review very few of the cases that come before it in any given year, and in fact agrees to review only a handful of tax cases each year.

Supreme Court specialists view the Court’s recent announcement as especially unusual because (a) the federal appellate courts were not “split” over whether the regulation was valid (in fact, only one federal appellate court had considered the validity issue); (b) the decision under review upheld the regulation and thus did not “open the floodgates” to a large revenue drain; and (c) the federal government’s lawyer in the Supreme Court, Solicitor General Elena Kagan, opposed review.

Having said that, the issue is important because it controls about $700,000,000 in tax revenue annually, so the revenue at stake under refund claims that are or will be filed totals many billions of dollars – an amount which, back in the day, would have been regarded by Senator Everett McKinley Dirksen  as “real money.”

This Supreme Court’s unusual action respecting this second “bucket” of claims has prompted plenty of speculation about what the Court might be thinking.  Probably the most common theory is that at least four members of the Court – the number of votes required to grant review – are mildly inclined to strike down the 2005 Regulation.  But there are other theories, too.

The validity question before the Court is starkly posed because of the IRS’ March 2, 2010 announcement that refunds will be paid under the Student Exception for quarters before April 1, 2005.  Highly relevant to the Court’s eventual ruling will be the fact that in the course of the courtroom battles that led to the IRS’ announced capitulation, four of the federal courts of appeal held that the Student Exception statute plainly contradicted the IRS’ core argument that the services performed by medical residents were categorically ineligible for the Student Exception from FICA tax.

The holdings of these four courts of appeals appear to leave no room for the 2005 Regulation, which attempts to codify the rule that services performed by medical residents are categorically ineligible for the Student Exception – the same rule that was rejected by those four courts.  It is black-letter law that a regulation may not contradict the plain meaning of the statute that the regulation purports to implement.  For its part, the IRS contends that the Treasury Department has broad latitude to adopt regulations, even for the purpose of fortifying its position in litigation, so the 2005 Regulation is valid and has the force of law.

The Supreme Court will hear argument next fall.  Its opinion is expected in March 2011.

The Court’s deliberations will take place with only eight justices participating, instead of the usual nine.  Justice Stevens is retiring, and his likely replacement, Elena Kagan, will not participate in deliberations because she signed the federal government’s brief stating its position on whether Court review should be granted.  (As noted, the brief opposed review.)

In the event of a four-to-four tie among the eight participating Justices, the resulting opinion would have no precedential effect, and the decision of the Eighth Circuit, upholding the validity of the Regulation, would stand.  The Eighth Circuit precedent would remain controlling for teaching hospitals bringing suit in federal district courts in the Eighth Circuit.  (But teaching hospitals in the Eighth Circuit could avoid that precedent by bringing suit in the Court of Federal Claims.)  But the Regulation would be open to challenge in all other courts of appeals -- including the four that previously rejected the IRS’ “categorically ineligible” argument.  Other cases challenging the regulation would thus work their way through the courts and, if a “split” among the circuits addressing the regulation emerged (a likely occurrence in view of the four circuit cases discussed above), the issue might end up in the Supreme Court again, at least if the Court has a different composition at that point.

In view of these developments, teaching hospitals are well advised carefully to consider their next steps – steps designed to protect their rights, and the rights of their residents, to tax refunds for taxable quarters after March 31, 2005.  A teaching hospitals should always continue to remit the FICA tax in accordance with the terms of the 2005 Regulation -- unless and until the regulation is struck down with finality for it or for all taxpayers.

Many teaching hospitals (often banding together) have already decided to file tax-refund suits and proceed to a final money judgment -- without waiting for the Supreme Court’s March 2011 ruling, and without seeking a stay of their case upon filing.  A critical issue for teaching hospitals that bring suit is choice-of-forum:  they can go either to their local district court (unless it is in the Eighth Circuit) or to the Court of Federal Claims, which has nationwide jurisdiction.  There are pros and cons to each forum (e.g., jury v. no jury; variations in docket speed and judicial composition; the ability or inability to join forces with  plaintiffs nationwide) which should be addressed with tax counsel experienced with tax-refund suits in both forums.

Teaching hospitals should also bring their administrative refund claims up to date and insure that their claims’ content is a sufficient predicate for suit, so that all quarters through the present can be resolved in the suit.


The pace of the legal developments respecting FICA tax on resident stipends has accelerated rapidly during the past few months, in sharp contrast to the languid pace seen in years past.  Developments in this area can be difficult for a casual or weary observer to follow, especially because there are two “buckets” of claims that are radically different from each other (because of the presence of the dubious 2005 Regulation) – and the two “buckets” involve radically different next steps.

The FICA tax at stake in the second “bucket” is huge, for both teaching hospitals and residents.  The next steps on this “bucket” present alumni-relations and even risk-management issues.  In light of recent developments, this “bucket,” in particular, warrants the close attention of hospital financial executives and in-house counsel -- and it presents considerable urgency, as many teaching hospitals have come to appreciate.  But these are good problems for hospital executives and counsel to have.
* Thomas D. Sykes is a shareholder in the Tax Practice at Greenberg Traurig, LLP, resident in its Chicago office.  The views expressed herein are those of the author, and not necessarily of Greenberg Traurig, LLP.  The expressed views are not intended to constitute legal or tax advice, which the author is permitted to provide only to clients that have engaged him for that purpose.  © 2010 Thomas D. Sykes.

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