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Supreme Court Rules for IRS, Against Medical Residents

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January 11, 2011

By Michael Cohn

The Supreme Court has ruled unanimously in favor of the Internal Revenue Service, saying that medical residents are full-time employees who are subject to payroll taxes and don’t qualify for the student exemption.

The case, Mayo Foundation et al v. U.S., involved the Mayo Clinic in Minnesota and a hospital operated by the University of Minnesota. In late 2004, the IRS made a rule change and said that medical residents, as doctors in training, no longer qualified for the student exemption from paying Social Security and Medicare FICA taxes. The judges, in an 8-0 decision, from which the newest justice, former Solicitor General Elena Kagan, recused herself, decided in favor of the IRS change, which will apply to residents’ stipends paid after April 1, 2005. The IRS has already decided to exempt medical student wages paid prior to April 2005 (see IRS to Honor Medical Resident FICA Refund Claims).

The Treasury will earn an estimated $700 million a year in future revenue as a result of the change, according to SCOTUSblog.

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Mayo residents generally spend the bulk of their time—typically 50 to 80 hours a week—caring for patients, the court noted. Mayo pays its residents annual stipends of over $40,000 and also provides them with health insurance, malpractice insurance and paid vacation time.

Chief Justice John Roberts, writing for the majority, said the hospitals are engaged in education, but he rejected the hospitals’ argument that the students should be taxed on a case-by-case basis. He upheld an appeals court ruling, citing precedents in cases involving the National Muffler Dealers Association v. United States and Chevron USA v. Natural Resources Defense Council.

“We do not doubt that Mayo’s residents are engaged in a valuable educational pursuit or that they are students of their craft,” he wrote. “The question whether they are 'students' for purposes of Section 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 of the Court of Appeals must be affirmed.”

Another former Solicitor General, Ted Olson of Gibson, Dunn & Crutcher, who represented Mayo and the University of Minnesota before the Supreme Court, issued the following statement, according to local station KIMT: "We are disappointed that the Supreme Court decided to uphold the Treasury Department's exclusion of medical residents from the scope of the Student Exemption enacted by Congress. 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."

In another tax-related case decided by the Supreme Court on Tuesday, Kagan participated in the decision and wrote her first opinion for the court. She and the other justices in that case, Ransom v. FIA Card Services, ruled that under bankruptcy law, a person who owns a car but is not making loan or lease payments on the vehicle cannot claim a Chapter 13 deduction for car ownership. The case involved a Nevada man named Jason Ransom, who wanted to claim a deduction of $471 a month as a car ownership expense for his 2004 Toyota Camry.

Kagan analyzed the IRS standards for the monthly expenses that debtors can claim under the bankruptcy code to reduce their disposable income.

Writing for the court in an 8-1 decision, Kagan said, “But the choice here is not between thrifty savers and profligate borrowers, as Ransom would have it. Money is fungible. The $14,000 that Ransom spent to purchase his Camry outright was money he did not devote to paying down his credit card debt, and Congress did not express a preference for one use of these funds over the other.”

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