Mayo Foundation for Medical Education v. U.S., Civ. No. 06-5059 (RHK/JSM).

• Decision Date: 03 August 2007
• Docket Number: Civ. No. 06-5059 (RHK/JSM).
• Parties: MAYO FOUNDATION FOR MEDICAL EDUCATION AND RESEARCH and Mayo Clinic, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Minnesota

503 F.Supp.2d 1164

MAYO FOUNDATION FOR MEDICAL EDUCATION AND RESEARCH and Mayo Clinic, Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. No. 06-5059 (RHK/JSM).

United States District Court, D. Minnesota.

August 3, 2007.

COPYRIGHT MATERIAL OMITTED

Thomas W. Tinkham, John W. Windhorst, Jr., Christopher R. Duggan, Kristina W. Carlson, Emily L. Fitzgerald, Dorsey & Whitney LLP, Minneapolis, MN, Robert M. Moore, Jr., Joanne L. Martin, Mayo Clinic, Rochester, MN, for Plaintiffs.

Michael R. Pahl, Trial Attorney, Tax Division, United States Department of Justice, Washington, D.C., for Defendant.

MEMORANDUM OPINION AND ORDER

KYLE, District Judge.

INTRODUCTION

Plaintiffs Mayo Foundation for Medical Education and Research ("MFMER") and Mayo Clinic ("Mayo") commenced this action against Defendant United States of America for the refund of FICA taxes withheld and paid on Mayo's medical residents' stipends during the second quarter of 2005. The amount of Mayo's claim is $1,676,118.06, plus interest. This Court held in 2003 that stipends paid to medical residents in 1994-1996 qualify for the "student" exclusion from FICA taxation and that Mayo is a "school, college, or university" for purposes of the exclusion.¹ The IRS amended its regulations in 2004 (effective April 1, 2005) and, as a result, medical residents no longer qualify for the exclusion. Mayo now moves for summary judgment. For the reasons set forth below, the Court will grant Mayo's Motion on the basis that the amended regulations are invalid.

BACKGROUND

I. Plaintiffs MFMER and Mayo

Plaintiffs MFMER and Mayo are nonprofit corporations organized in Minnesota with their principal places of business in Rochester, Minnesota. (Pls.' Mem. at 2.) MFMER is the agent of Mayo for purposes of withholding and remitting FICA taxes and filing related tax returns. (Pls.' Mem. at 2.) MFMER filed the tax return and the refund claim involved in this case. (Id.)

Mayo operates graduate medical education programs for medical residents and fellows ("residents").² Most of these programs are formally reviewed and approved by national accreditation bodies. (Id.) Residents are enrolled in the programs, register for courses, attend lectures, perform research, and participate in "teaching rounds" and patient care. (Id.)

Residents also receive grades or written evaluations for their performance in each course and may be terminated from the programs for failing to satisfy academic standards. (Id.) Mayo pays a stipend to the residents for the purpose of providing a minimum level of financial support during their enrollment. (Id. at 3.) Finally, residents receive formal certification upon completion of the programs. (Id.)

II. An Overview of the FICA Tax

The Federal Insurance Contributions Act ("FICA") imposes taxes upon employers and employees for the support of the social security system. See 26 U.S.C. § 3101 et seq. FICA taxes must be paid on "wages." Id. FICA defines "wages" as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash." 26 U.S.C. § 3121(a). Employers collect FICA taxes by withholding the required amount from their employees' wages. See 26 U.S.C. § 3102(a). Employers also pay FICA contributions that equal the amount withheld from their employees' wages. See 26 U.S.C. § 3111(a). "Thus, FICA taxes are `paid in part by employees through withholding, and in part by employers through an excise tax.'" Ahmed v. United States, 147 F.3d 791, 794 (8th Cir.1998) (quoting United States v. Lee, 455 U.S. 252, 254 n. 1, 102 S.Ct. 1051, 71 L.Ed.2d 127 (1982)).

FICA excludes several categories of "service" from "employment," including "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." 26 U.S.C. § 3121(b)(10).

III. Amended Regulations

In February 2004, the Internal Revenue Service ("IRS") published a Notice of Proposed Rulemaking to amend its regulations governing the definition of "school, college, or university" and "student" for purposes of the student-FICA exception under 26 U.S.C. § 3121(b)(10). See Student FICA Exception, 69 Fed.Reg. 8604-8606 (proposed Feb. 25, 2004) (codified at 26 C.F.R. § 31.3121(b)(10)-2(c),(d)). The IRS explained that the proposed amendments were designed to address whether services performed as "on-the-job training" are excluded from employment under the student-FICA exception. Id. In particular, the IRS acknowledged that the Eighth Circuit addressed this issue with respect to medical residents in Minnesota v. Apfel, 151 F.3d 742 (8th Cir.1998). See 69 Fed.Reg. at 8605. In Apfel, the Eighth Circuit concluded that services performed by medical residents at the University of Minnesota did not constitute employment for social security purposes. Apfel, 151. F.3d at 745, 748.

The IRS also explained that the proposed amendments were designed to address whether an organization carrying on both noneducational and educational activities is a "school, college, or university" within the meaning of section 3121(b)(10). See 69 Fed.Reg. at 8605-06. The IRS indicated that it disagreed with this Court's holding in Mayo I that Mayo is a "school, college, or university" for purposes of the exclusion. Id. In Mayo I, this Court rejected the Government's argument that the "primary purpose" of an organization determines whether the organization is a "school, college, or university" for purposes of the student-FICA exception. Mayo I, 282 F.Supp.2d at 1013. The Court reasoned that the IRS. "opt[ed] instead for a simple and straightforward statement that the term `school, college, or university' should be taken in its commonly and generally accepted sense." Id. Nonetheless, the IRS stated that the proposed amendments would incorporate the "primary function" standard in the regulations. 69 Fed.Reg. at 8605-06.

On December 21, 2004, the IRS published its final amended regulations, which became effective for services performed on or after April 1, 2005.

A. Definition of "School, College, or University"

The amended regulations provide that:

[a]n organization is a school, college, or university within the meaning of section 3121(b)(10) if its primary function is the presentation of formal instruction, it normally maintains a regular faculty and curriculum, and it normally has a regularly enrolled body of students in attendance at the place where its educational activities are regularly carried on. See section 170(b)(1)(A)(ii) and the regulations thereunder.

26 C.F.R. § 31.3121(b)(10)-2(c) (emphasis added).

By comparison, the pre-amended regulations provided that "[t]he term `school, college, or university' within the meaning of this exception is to be taken in its commonly or generally accepted sense." 26 C.F.R. § 31.3121(b)(10)-2(d) (Pre-4/1/05 Regulations).

B. Definition of "Student"

The amended regulations provide that student status ("General Rule") is determined by "the relationship of the employee with the organization employing the employee." 26 C.F.R. § 31.3121(b)(10)-2(d). In particular, an employee is a student if the services he or she provides are "incident to and for the purpose of pursuing a course of study." 26 C.F.R. § 31.3121(b)(10)-2(d)(3)(i). In addition, "[t]he 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." Id. The "educational" and "service" aspects of the relationship are based "on all the relevant facts and circumstances." Id.

The educational aspect of the relationship is generally evaluated based on the employee's "course workload" relative to the "full-time" course workload at the school, college, or university. 26 C.F.R. § 31.3121(b)(10)-2(d)(3)(iv). The service aspect is evaluated based on the employee's normal work schedule, number of hours worked, whether the employee is a "professional" or a "licensed professional," and whether the employee is eligible to receive certain kinds of employment benefits. 26 C.F.R. § 31.3121(b)(10)-2(d)(3)(v).

C. Full-time Employee Exception

The amended regulations provide that "an employee whose normal work schedule is 40 hours or more per week is considered a full-time employee" and therefore services performed by that individual are "not incident to and for the purpose of pursuing a course of study." 26 C.F.R. § 31.3121(b)(10)-2(d)(3)(iii). Also, an employee's "normal work schedule" is "not affected by the fact that the services performed by the employee may have an educational, instructional, or training aspect." Id. Consequently, a medical resident who works 40 or more hours per week does not qualify for the student exclusion from FICA taxation.

In contrast, the pre-amended regulations provided that student status shall be determined "on the basis of the relationship of such employee with the organization for which the services are performed." 26 C.F.R. § 31.3121(b)(10)-2(c) (Pre-4/1/05 Regulations). Thus, "[a]n employee who perform[ed] services in the employ of a school, college, or university, as an incident to and for the purpose of pursuing a course of study" was a student. Id. The pre-amended regulations did not have a full-time employee exception.

IV. Mayo's Refund Claim

Mayo withheld and paid FICA taxes on the stipends it paid to the residents for services performed on or after April 1, 2005. Thereafter, Mayo timely filed a refund claim with the IRS for $1,676,118.06. The IRS did not act upon the claim and Mayo filed this action. See 26 U.S.C. § 6532.

STANDARD OF DECISION

Summary judgment is proper if, drawing all reasonable inferences in favor of the nonmoving party, there is no genuine issue as to any material fact and the moving party is...